Finances

Credit & Overspending

"Thrift used to be a basic American virtue. Now the American virtue is to spend money."
- David Brinkley

Discussion: Is Credit a Tool or a Trap?

Credit can be a tool or a trap, depending upon how it is handled. Used well, credit can be an asset that helps build wealth as part of a financial plan. Credit can allow you to use the goods and services you need while you are paying for them. Credit can also provide a temporary solution to financial emergencies, such as when the water pump in the family car needs to be replaced. Used unwisely, credit can lead to excessive debt or even bankruptcy. Financial experts advise that credit/debt payments, excluding a home mortgage, should equal no more than 15% to 20% of your monthly take-home pay.

Help! We're Already Over-Extended

Research has shown that couples who file for bankruptcy have often experienced a spell of unemployment shortly before filing. What seems to happen is when one wage earner is laid off, there often is not enough of an emergency or reserve fund to tide them over. Then they begin using credit to pay for necessities. If you are in a situation where you need to start getting out of debt, you might think about the PowerPay plan of repayment.

The PowerPay plan is a simple three-step process, but it takes willpower.

1. Stop borrowing or charging until current debts are paid.
2. Make PowerPayments on current obligations. Making PowerPayments means that as soon as one debt is totally repaid, the monthly payment from that loan is applied to the next debt. Money from paid loans continues to be combined toward other debts until all are paid (see below for an illustration). The total amount of money spent each month remains constant until all are paid. It is not necessary to come up with extra money to be successful. When one creditor is paid, commit that money to a different debt rather than spending it something else. In this example, all debts have been repaid in six months.

The first bill paid can be the one with the lowest balance, the one with the highest interest rate, or the one with the shortest term. If you have some extra money coming in (e.g., a tax refund or some overtime) you can apply it to pay down your debts even more quickly.

PowerPayment Plan

	Monthly Payments
Creditors	Jan.	Feb.	Mar.	Apr.	May	Jun.
Visa $50.00	50	Paid
MasterCard $250.00	100	150	Paid
Sears $225.00	25	25	175	Paid
R.C. Furniture $1,850.00	275	275	275	450	450	125
Total payments	450	450	450	450	450	125

3. After the last debt is paid off, continue making PowerPayments to yourself as if you were following the original payment schedule. This will allow you to build up an emergency or reserve fund. This way your money is earning interest rather than costing you interest.

Exercises