Friday, April 19, 2024

LOUISE FAIRSAVE: Debt and credit


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CREDIT HAS BEEN given a bad name, especially to baby boomers. What little money management advice they got from their parents usually included some form of the admonition to “stay away from debt”. However, there is good credit and bad credit. Today’s article looks at the good and bad faces of credit.

In every country’s population, there are usually a few persons who are self-made millionaires. Most of them have done so by leveraging cedit wisely to build wealth. A good credit score/rating gives the holder access to lower interest rates on loans, quicker loan approvals, and an easier time in securing debt financing for business opportunities. 

Yet having a good credit rating may encourage persons to extend their debt to the point of eventually getting a bad credit rating. For example, this may happen when a credit card holder incurs credit on the card at higher and higher levels with a view to increasing the maximum limit.

Eventually, that maximum limit may go beyond the means of the holder to repay consistently. Then, good credit passes over to bad credit which, in turn, will severely damage the credit card holder’s credit rating.

Excellent credit rating

Bankers, other lenders and extenders of credit like businesses and service providers examine your use of credit.

They look for timely payment of bills, credit cards, mortgages and other debt. You may expect to have an excellent credit rating if you pay early or on time and have no late or missed payments. However, if you always pay in full in cash, you may not have a credit rating.

Establishing a good credit rating involves applying your prudent spending and careful personal financial management into handling debt. For example, the responsible use of a credit card or a mortgage will establish a good credit rating. 

In order to avoid interest charges as much as possible, when your credit card bill arrives, the full amount owing should be paid on or before the due date.  Alternately, if the full amount is not affordable at that time, every effort should be made to exceed the minimum payment. 

Similarly, acquiring a personal or business property by way of a mortgage reflects that the mortgagor is a responsible spender once he meets the related debt obligations on a timely basis. This will go a long way in establishing a good credit rating.

Good debt has been utilised over the years to build personal and corporate wealth. Whenever the value of the project or product financed increases faster than the cost of the debt which made ownership possible, the debt holder is leveraging good debt, subject to one critical proviso: the debt holder must be readily able to service the debt payments as they fall due.  

So, good debt is identified by these two important criteria: the value created exceeding the cost of the debt, and the ability to comfortably meet the repayment necessary.

Typically, additional tax incentives help to ease the borrowing costs and real estate has proven over the years to be an asset that appreciates over time leading to the increase in net worth of the mortgagor.

Denial of credit

On the other hand, a bad credit rating usually makes it more expensive to borrow from lenders. In dire cases, bad credit can result in outright denial of credit. A bad credit rating arises from non-repayment of debt, or late or missed payment instalments. That is why pursuing higher and higher credit limits and more and more credit may lead you down the road of bad credit.

Wise spending will always entail living within your means, and maintaining your good money habits in order to attain and maintain a good credit rating. 

Next time there will be some scenarios to test your understanding of good credit.

• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.

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