Personal Financial Management: TOP 5 Questions--#1: Credit and Credit Cards

On January 20, 2011, I had the pleasure to lecture at Wheaton College to our ROTC-Class of 2011 cadets. This was my 7th year in a row that I've provided a class on Personal Financial Management. Each year the cadets have great questions and I thought I'd share five of those with you over the coming weeks.

Question #1: How do we establish good credit and should we be using credit cards?

This is a great question, especially today when students have many expenses and little time for employment. Its also a great discussion for us non-students who are managing our budgets each month and deciding what we can put on credit and what we should buy with cash.

First, how do we establish good credit. Two important steps: (1) To have credit, you must use credit. Therefore, apply and use a credit card. (2) Once you have the credit card, use it wisely and pay it off in full each month. This will allow you to build a credit history and by paying your balance on time and in full each month you will establish a good credit score.

Second, Should you use credit? As explained above, yes you have to use credit to establish a credit score. However, the key is paying the credit card balance in full each month. DO NOT CARRY A BALANCE!

Let me share a few statistics with you (source: www.creditcard.com, Credit card statistics, industry facts, debt statistics, January 2011):

1. Americans owe $852.6 billion on credit card/revolving credit accounts
2. Total US consumer debt is $2.45 trillion dollars
3. Average credit card debt per household is $15,788 *60% of credit card holders carry a balance.
4. National average default rate is 27.88%
5. Average APR on credit card offers: 14.35%
6. College Seniors are graduating with an average credit card debt of $4,100.

These stats tell us that Americans continue to spend more than they make and therefore they are going into debt. Bad credit or the misuse of credit are the biggest reasons Americans do not achieve their financial goals and one of the main reasons they end up living paycheck to paycheck. Let me illustrate based on the above information how Americans are derailing any potential for long-term financial success:

If you are in the "average" and carry a credit card balance of $15,788 with an APR of 14.35% you would pay $2,265 in interest annually. The cost over time equals:

Yr 5: $11,325
Yr 10: $22,650
Yr 20: $45,300
Yr 30: $67,950
Yr 40: $90,600

YES, over a 40 year period you have paid the credit card company over $90,000 in interest! [At this point, you have forgot what you even bought!]

Now, if instead you paid in cash or at least paid your credit card off in full each month and then invested the $2,265 each year in an investment account earning 8% you would accumulate:

Yr 5: $13,287
Yr 10: $32,812
Yr 20: $103,650
Yr 30: $256,586
Yr 40: $586,763

YES, by managing your spending and not going into debt you have accumulated over $586,000" [An investment account statement with a balance is much better than a credit card statement with a balance!]

That is a huge difference and the reason why some of us achieve long-term financial success and while others don't! And quite frankly its up to YOU..only YOU can decide to not buy it if you don't have the money to pay for it.

I hope this information motivates you to have a credit card, BUT to pay it in full each month. Instead of PAYING interest, EARN interest and build yourself a nest egg of over half a million dollars!

Wishing you Great Financial Succe$$,

BILL

"If it depreciates pay in cash!"