How To Borrow Money Wisely

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While it may be true that money makes the world turn, credit does most of the heavy work. The funds that individuals, businesses and governments borrow to fund new projects, purchases, hiring sprees and expansions is the economy’s lifeblood, providing livelihoods for millions of hard-working folks.

Not all loans are of equal merit, however. The financial crisis of the late 2000s made all too clear the perils of “easy money,” loans that for one reason or another should never have been made. In this case, the initial problem of mortgages made to people who couldn’t really afford them was compounded by a cascade of financial malfeasance that turned the loans into securities with uncertain but clearly-inflated values. These, in turn, were bought and sold on the world’s credit markets. When it became clear that many of the mortgages would never be repaid, the value of these securities collapsed and the whole house of cards came crashing down.

The cautionary tale of the recent financial crisis suggests that borrowing money isn’t always a good idea. However, there are some purchases that you simply can’t make without the help of a credit facility.

Since your credit score fluctuates based on your perceived ability to repay the money that you borrow, the credit-related decisions that you make today can affect your ability to borrow money at an affordable rate in the future.

Among the most flexible and easy-to-use credit facilities, credit cards allow you to make purchases without paying for them at the point of sale, and most have provisions built into their cardholder agreements that allow for a “grace period” of deferred payment for up to a month after you receive your monthly bill. When you make a credit-card purchase at the outset of a monthly billing cycle, you may not have to pay for it for nearly two months. In the day-to-day world of personal finance, that’s a comfortable span of time.

Unfortunately, it’s possible to get a little too comfortable with your credit cards and charge more than what you can afford to pay. To subtly encourage excessive behavior without inviting catastrophe, credit card companies often set their customers’ credit limits higher than what their income and net worth would suggest that they can afford. After all, the ability to buy products and services without paying for them plays into the natural human desire for instant gratification, regardless of the consequences.

Once you miss your first credit card payment, you’ll begin accruing interest at double-digit rates. Many of the so-called “low-interest” credit cards available at carry APRs of 10 to 20 percent, which vary in response to market conditions and your personal credit rating. Even if you stop using your card, the balance that you’ve accumulated will continue to accrue interest until you pay it down in full.

If you’re unable to stop using your card, either because you’re spending more than you take in each month or you’re dealing with a serious life event like unemployment or a costly family medical issue, your balance will continue to grow.

It may be possible to maintain a significant balance on a single credit card by continuing to make meaningful, on-time payments at the end of each billing cycle, but you’ll lose a great deal of money in the process. For instance, a 15 percent APR on an average balance of $5,000 will cost you $750 per year in interest charges alone.

Running balances on multiple cards is more difficult to pull off and greatly increases the chances that you’ll fail to make a payment at some point. If and when you do miss a monthly payment, you’ll begin to accrue penalty interest, which may approach 30 percent annually.

On top of that, your issuer may add various fees and penalties to your account balance. At this point, you’ll find it increasingly difficult to extricate yourself from your spiraling debt situation on your own and may need to enlist the services of a debt settle.

Elijah Agor, an advocate for vulnerable adults, writer, and a chocolate chip cookie connoisseur.

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