Unit1 Break The Debt Cycle.pdf

Break the

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Contents

Introduction

4

The Debt Cycle

5

Causes of the Debt Cycle ... 5

Symptoms of the Debt Cycle ... 8

Dangers of the Debt Cycle ...10

Your Debt Ratio

13

Good Debt vs. Bad Debt

14

Payday Loans ...19

Pawnshop Loans ...20

Title Loans ...21

High LTV Home Equity Loans ...21

Advance-Fee Loans ...21

Break the Debt Cycle

22

Spend Within Your Means ...23

Pay-off Debt, Any Way You Can ...23

Learn the Language of Lending ...23

Get Your Credit Report ...25

Understand Bankruptcy ...26

Seek Credit Counseling ...27

The Bottom Line ...29

Introduction

Let’s face it; a debt-free existence may be unrealistic. And, in the world of personal finances, there is “good” debt and there is “bad” debt. So it’s critical for you to learn the difference and how these can affect your finances.

Borrowing money—whether it’s the use of a credit card to purchase something, a debt consolidation loan, borrowing to buy that diamond ring, a stereo, or a car, or getting a second mortgage to replace your furnace—requires that you typically pay back more than the original cost of whatever it is you are buying.

An interesting concept arises here. You can’t afford to buy something with cash today, so you spend more money than it’s worth. If you can’t afford it, don’t buy it. Now there are obviously certain exceptions to that rule, such as the purchase of a house or car. There are also certain emergencies that, if your emergency fund doesn’t cover the need, such as medical expenses, you may have to borrow money for the good of you and/or your family.

But using credit comes at a cost, and self-discipline is necessary to prevent and manage (if necessary) the high cost of borrowing. Today it is very easy to get the credit you need—especially for those bad debts that can get you in trouble. It doesn’t help that virtually everyone has access to high-interest credit cards, payday loans, and other harmful options for borrowing money.

The Debt Cycle

The debt cycle refers to a pattern of behavior related to income, expenses and credit use. There are three phases that cause a cycle of debt:

1. Expenses exceed monthly income, so...

2. Credit is used to cover the difference, and...

3. The additional expense of paying-off the credit used to cover normal expenses creates a need for more credit to supplement monthly income.

This concept is best thought of as a spiral—after a period of time you may eventually hit bottom and will be unable to use credit to cover the difference. At this point, you switch from having to pick from bad choices to having to deal directly with consequences.

Here’s a real-life example: A family earns a monthly income of $3,000, and they typically have monthly expenses of $2,800. But one month they have an unexpected expense—a car repair bill for $1,200. With no cash in savings, they borrow money to fix their car. Next month their income has not increased, but in addition to their normal expenses they must begin to pay-off the money they borrowed for the car repairs. Again, without enough income (and no savings), they are forced to use credit again to cover expenses—this time they pay for groceries using a high-interest credit card—and the debt cycle has begun.

Causes of the Debt Cycle

It is not uncommon for individuals in or heading towards the debt cycle to exhibit one or more of the following behaviors:

· Having a poor (or non-existent) savings plan. Without a plan for how you’ll save money, you run the risk of not having money for unanticipated needs or wants, and then you find yourself in a position to have to borrow money to fund those needs.

· Carrying a balance on credit cards and paying only the minimum monthly payments. This is almost a guarantee that you will remain in the debt cycle. Using credit cards responsibly is the way to go, but as you’ll learn later, making only minimum payments each month can trap you into revolving debt and cost you lots of money.

· Being unclear about your current financial status. If you make decisions regarding finances from an uninformed perspective and without all of the financial facts, you’ll almost certainly end up in a situation where you have lost control of your finances.

· Lack of an emergency fund. Life is full of unknown expenses, and not having a plan for how to deal with these little financial surprises can catapult you into the debt cycle. For instance, if you had unexpected car trouble that required an expensive repair, not having an emergency fund to cover this could cause you to have to take money from other obligations (i.e. rent payment, utilities) to cover the difference in this situation.

· Struggling to make ends meet on the most basic financial needs. This is a clear indicator of being in the debt cycle. If the fundamental expenses— rent, car payment, groceries and clothing—are difficult to cover, you’ll end up using credit to cover these needs.

· Regularly maxing out your credit limit on several or all of your credit cards. Typically, this indicates that you are living beyond your regular financial means. Maxing out cards, paying-off only a fraction of the balance then charging to the maximum credit limit again is a very literal representation of being caught in a difficult to escape cycle of debt.

Shopping and Spending Problems

If you are using credit cards to purchase necessary items, it is clear that you are in a cash flow crisis situation where incoming funds are either not sufficient to cover basic needs or incoming funds are being spent first on wants instead of necessities.

Frequently charging items with the intention of paying them off at the end of the month, but then finding that you’re financially unable to do so is a common game that people in the debt cycle play with their finances. When the time comes to make good on this promise, there are always more attractive things to spend the money on than repayment of a purchase already made and enjoyed.

and a feeling of not being strapped financially, the balances will eventually catch up to the ability to repay them—and it’s often too late to correct the financial problems without considerable strain.

Making whim purchases, particularly for large-ticket items, like a big screen television or expensive vacation, are indicative of not being in touch with the reality of the financial situation. The thrill of spending, in this instance, is overpowering to the sense of responsibility required to choose to save for such whim purchases, versus putting the purchase on a credit card.

Reliance on Money From Bad Sources

Depending on unpredictable income, such as specialty pay, cost-of-living adjustments, or hazardous duty pay can be an unstable way to plan the family budget. While these sources of income may be very legitimate, they also usually come with an end date on them. If a budget is reliant on temporary sources of income, the financial order of things will be upset when that special income is no longer being received.

Frequently borrowing from friends and/or family can cause an uncomfortable situation. Despite their willingness to help in some instances, the strain of bringing financial difficulties into a relationship in this way can have a far higher cost than forgoing the purchase in the first place.

Dipping into your savings account or using credit card cash advances to cover basic expenses is yet another indicator that the inbound funds are outpaced by the outgoing funds each month. At some point, the credit cards are maxed out and the savings is depleted—and the debt cycle has already begun to pull you into the spiral of financial difficulty.

Payday loans, particularly if used on more than a single occasion, can create a rollover spiral that traps you. When the initial transaction is made and the fee is added, the payday lender will offer you the option to continue rolling over the balance by simply paying the fee all over again. The result to the borrower is that the fees continue to pile on and the principal balance from the original transaction is barely even touched.

Emotional Stuff

Arguing about money is one of the known and certain fallouts of being in the debt cycle. Financial matters are very personal and at times uncomfortable to discuss, even with loved ones or friends. Embarrassment that people close to you will find out just how deeply in debt you really are keeps many people from seeking assistance to plan their way out of the debt cycle. Keeping the financial facts secret can often lead to making the problem even worse.

The self-confidence to engage in normal money discussions can be diminished by being in the debt cycle. If people know that their financial house is not in order, they might find it difficult to participate in financial conversations with others out of fear that something they say might expose the current state of their own personal finances.

In addition, the early stages of the debt cycle can be enormously deceiving. It can cause people to think any or all of the following until the credit runs out:

· “I can buy what I want, when I want it.”

· “I can have fun when I’m stressed—and I’m stressed a lot about money!”

· “No money? No problem! I’ve got credit!”

· “Freedom to live life the way I want to live it.”

· “I’m going to make more money in the future—I’ll pay it off then.”

Credit cards and the “thrill of spending” are very addictive. This addiction, like any other, takes training and discipline to break. It’s worthwhile to consider the fact that the divorce rate is higher among families with financial troubles, and physiological problems may also result from being in the debt cycle. The anxiety and stress caused by barely scraping by or not being able to make ends meet and see a positive financial future can cause serious health conditions.

Symptoms of the Debt Cycle

The first step needed is to look at your current situation and determine if you are in the debt cycle, or in danger of falling into it. Below are several indicators that you and your family are in or are in danger of entering the debt cycle:

· Your credit card balances are increasing, but you have no way to increase your income.

· You are only paying the minimum amounts required on your accounts, or less than the minimums. Furthermore, the amount of finance charges being added to your balance almost equals your monthly payment.

· You have two or more active credit cards opened.

· You have come close to maximizing all of your credit cards.

· You are charging more each month than you are paying.

· You are working overtime to keep up with your credit card payments.

· You don’t keep track of what you owe; you adopt the attitude of “ignorance is bliss.”

· Your creditors are calling your Commanding Officer, reporting delinquent bill payments.

· You are using your credit card to buy necessities like food or gasoline and leisure items like CDs and DVDs.

· You use your credit card because you have no money to make your purchases.

· You are hiding the true cost of your purchases from your spouse.

· You’re playing the card game by signing up for every credit card that sends you an unsolicited offer.

· With all the payments you make each month on credit card debt, you have no extra cash for savings and investments.

· You do not cut up your card after you pay off the balance.

· You have no emergency fund and no light at the end of the tunnel.

· You cannot get any additional credit because of a poor credit report. Look for a pattern. There’s no magic number of indicators to determine if you’re in the debt cycle. Even if you see yourself in several of these above instances, you still might be able to deal with your credit crunch on your own. Similarly, paying only the “minimum payment required” once in a while could be acceptable.

Dangers of the Debt Cycle

The risk of default (not paying your credit obligations as agreed) is ever present when you’re in the debt cycle. Defaulting on obligations can have serious consequences.

If you don’t make monthly payments, you'll be in default, which means: · You may lose your security clearance

· You may be discharged from the service

· You could owe the entire balance of the loan immediately

· The default shows up on your credit record, damaging your chances of qualifying for other forms of credit

· Your wages may be garnished—or partially withheld by the government— to pay your credit obligations

· You may be subject to legal action and have to pay attorneys’ fees

· Your account may be referred to a collection agency

· You may have to pay collection fees, which could be as much as 25% of your outstanding balance

· You may lose federal and state tax refunds due to you

Drowning in Debt

When you are in the debt cycle, it can seem like there is no way out! This can be especially true when you consider how easy it is to stay in debt once you’ve gotten there. One example is making minimum payments on credit cards, which can lead to a spiraling cycle of debt.

Each month your credit card statement comes, and you have several options: you can make the minimum payment, pay a substantial portion of the bill, or pay the full balance. Paying the minimum keeps you out of trouble with creditors, but it’s much more costly in the long run. You’ll pay interest on a balance that won’t decrease very rapidly. Paying a substantial portion of your bill each month will lower your balance more effectively, and thus lower the interest you’ll owe. Better yet, paying the full balance means avoiding a finance charge entirely.

purchase price. If you paid the full balance immediately, you’d only pay the value of your purchase—$1,000.

This is why it is so important to pay more than the minimum payment when you make purchases on your credit cards.

Borrowing Affects Borrowing

Since money is the issue at hand, one of the most important concepts to understand is how much it costs to borrow it. The amount of interest you are charged is largely determined by how you score with credit agencies. In particular, your FICO score is the probably the most common measurement used by companies to determine your creditworthiness. So it’s important for you to understand your credit, and how it can affect your ability to borrow money when you need it.

The largest contributing element to a credit score is your payment history. A review of your payment history includes the following:

· Number of accounts delinquent, number of public records or collection items and how severe the delinquency

· Dollar amount past due on accounts

· Length of time that has passed since the last instance of delinquency or report of a collection item/public record

· Number of accounts that are reporting paid as agreed

The second largest contributing element to your credit score is measured by how much an individual owes in obligations, including:

· Total amount owed and on specific account types (i.e. amount owed on revolving debt)

· Number of accounts that have a balance of some sort

· Number of current revolving account credit lines used

· Number of current installment accounts with balances remaining

The length of your credit history is the third contributor to the credit score, which examines:

· How long accounts have been open—overall and by account type

The amount of new credit you’ve applied for is the fourth major element of the credit score calculation. A review of this factor includes:

· Number of credit inquiries recently submitted and the subsequent number of recently opened accounts.

· Time passed since the most recent account opening and credit inquiry.

· Measurement of a positive credit history following any previous payment problems reflected in your credit report.

The types of credit used makes up the final element in the credit scoring process. This element examines the number of various account types, including installment-type credit (i.e. personal, home, auto and student loans) and revolving credit (i.e. credit cards).

Related to the debt cycle, you need to consider the fact that “borrowing affects borrowing”. In other words, the financial problems you incur while dealing with a cycle of debt (i.e. missing payments and racking-up debt) will harm your credit score, which in turn will make it much more expensive and difficult for you to borrow money.

Your Debt Ratio

An important measurement of your personal finances—and a key indicator of your risk for being in the debt cycle—is debt ratio. This is typically calculated by taking how much money you have going out in payments divided by your total gross income. Knowing your debt ratio will keep you aware of your finances so that you won’t get over your head in debt.

If your debt ratio is under 40%, your debt is probably at a level that is manageable. If your debt ratio is in the range of 40-45%, you should take caution with your finances and develop a plan for how to either increase your income or reduce your outstanding debts. If your debt ratio is 45% and above, you may be in trouble! At this stage, you should consider seeking professional assistance to create an escape plan from the trap of the debt cycle.

Good Debt vs. Bad Debt

So, you’re tired of all the debt you’re carrying and how it has put “handcuffs” on you and your family. You’d like to pay off or pay down your debt, but where do you get started?

In the world of personal finances there is good debt and bad debt. Examples of good debts include car, house, and education loans. These are good because it’s unlikely that you could come up with the full cash amount to buy the items covered, they fill needs in your life, and you may get tax advantages with some of these loans. Bad debts are the ones you want to get rid of first—these debts typically have high percentage annual percentage rates and are the kind you wish you never took in the first place (e.g., to fix the car because you didn’t have an emergency fund saved or to consolidate debts that became too much for you to handle).

Understanding the difference between good debt and bad debt will enable you to appropriately reduce your debt level, and avoid the wrong debts form this point forward, which will improve your long-term financial situation.

Good Debt

Good debt can include everyday obligations such as the car loan that provides you with needed transportation, the mortgage for the house you dream of owning, and the education loan so you can better yourself or your children. Thanks to good debt, you get to live in that great home, drive that nice car, and benefit from that education.

Think of good debt as things that appreciate or increase in value, such as homes and education. Without that mortgage, you would never be able to own a home that increases your assets; you would spend your life as a renter, increasing someone else’s value. Without that car, you would not be able to get to work. And, that education offers you even more opportunities to increase your income.

Bad Debt

So now you know about good debt. But you probably also know that the average citizen, military or civilian, will also take on other debts—many that should be avoided, if possible.

The true hazard to financial security is higher-rate debts, such as credit card purchases, cash advances, or payday loans. These debts eat away at your secure financial future, and this is where your past spending habits come back to haunt you. These debts give you none of the great benefits, such as tax-deductibility or the appreciation of value of an asset, which good debts do. Whenever you can, pay the bad debts down first.

Below is a detailed review of some common debts that, when used without discipline and responsibility for your actions, can cause a harmful cycle of debt.

Credit Cards

Credit cards can be an important tool for military personnel. For instance, when you get emergency deployed, having a credit card means you don’t have to carry as much cash. As a result, you also don’t have to assume all the risks of carrying cash. A credit card can also provide purchasing power quickly under these circumstances, especially if you don’t have cash that is readily accessible.

To use credit cards responsibly, you need to learn about them, which starts with an examination of the many different kinds of cards available to you.

Traditional Credit Cards

Cards such as Visa, MasterCard and Discover let you charge purchases up to your credit limit, a specific dollar amount that may be increased over time if you use your card responsibly. You’re required to pay at least the minimum amount of your outstanding balance every month, but you can always pay more or the balance in full. If you pay less than the minimum, be prepared to pay a penalty fee in addition to your balance. And if you consistently underpay for several months, your debt will mount and your borrowing privileges may be cut off.

Charge cards

Affinity and Store cards

Some cards have the logo of the credit card issuer (such as Visa or MasterCard), as well as that of a non-financial organization. Affinity cards can be used at any store that accepts regular credit cards. Store cards are usually issued by oil companies, retail chains, and department stores and can only be used within the organization where they’re issued.

These cards are usually offered with incentives and special promotions: opportunities to save money on your current purchase, take advantage of other savings in the future, contribute to a non-profit, or earn frequent flyer miles toward travel. These may be great deals, but they may cost you more money in the end. Certain store cards may have higher APRs than regular cards, and some may have shorter grace periods. Plus, the savings incentive may encourage you to spend more than you originally would have without the discount.

Debit Cards

Many banks offer debit cards as a feature of your checking account. These cards let you pay for purchases directly with money withdrawn from your checking account, and your account balance will be reduced by the amount that you’ve spent. But be careful: Your debit card doesn’t guarantee that you won’t overspend, especially if you have overdraft protection on your account. And overdrafts are very costly! On the other hand, using a debit card can be better than paying with a traditional credit card because you’re more likely to think twice about whether or not you should really buy something when swiping the plastic immediately takes money from your account.

Secured Credit Cards

If you’re just starting to use credit—or trying to recover from past credit problems—a secured credit card can help. It is similar to other cards, with one exception: a secured credit card is backed by a savings account at the bank of the creditor. You can charge up to the amount you have deposited in your savings account, or less if you choose a lower credit limit. Interest is calculated just as it would be on a regular card. And, if you fail to make a payment, creditors have the security of tapping your savings account to cover the debt. Just be aware that the creditor will deduct your principal, as well as the applicable penalty fees and charges, from your savings account balance.

Now that you’re familiar with the many different types of credit cards, it’s important that you learn how to use them. As mentioned above, credit cards are not necessarily bad, and they can be valuable when used responsibly. However, the way many people use credit cards cause it to be “bad debt” within their personal finances. Below are several issues to help you understand how credit cards can contribute to a debt cycle—and how you can avoid these pitfalls.

Increasing Debt

As stated in the introduction to this chapter, no matter what you buy with your credit card, you will pay interest on it and often other fees. Therefore, if you buy groceries on your credit card and you spend an average of $300 per month ($3,600 per year), you will be subjected to interest and fees throughout the year if you don’t pay off the balance at the end of the month. This can be quite costly over time and is not in the best interest of your financial future.

Credit cards represent a rolling line of credit. You have the option to make an unlimited number of purchases until you reach your pre-approved dollar amount, or credit limit. That amount can range from a couple hundred dollars to thousands of dollars, depending on your credit rating. Your contract with the credit card company requires you to pay at least a portion of the balance every month. This amount is considered the minimum payment required, and is often based on a percentage of the balance. Make every effort to pay more than the minimum payments on your credit cards. Depending on your balances, making just the minimum payments could take decades (and cost you thousands of extra dollars in that time) to have completely paid off.

When selecting a credit card, don’t forget to shop for the best deal related to interest rate, APR and fees. But before you shop, be sure that you really need the card; think about what you will be using it for and if you will have the self-control not to overuse it. Most importantly, understand that you are expected to pay the money back; nothing in life worth having comes without obligations.

All of Those Applications for Credit Cards You Receive

approved. Don’t let these words fool you—they may not be true. You still have to fill out the information requested on the application. The card issuers will then verify your income, employment, and credit history. Then and only then you may be approved.

“Limited-Time, Low Interest Rate” Deals

It is important to realize that not everyone qualifies for the rock-bottom interest rates promised in the card’s promotional literature. You receive the offer, fill out the application, transfer the balance, and then find out that you didn’t qualify for the great low interest rate you thought you would. The small print at the end of the offer explains this contingency. The big print “giveth” and the small print “taketh away.” Sometimes the grass is not always greener.

So, even though the offer might say 2.9 percent interest rate on balance transfers, you may only “qualify” for a 14.99 percent rate. As nice as all these deals seem on the surface, there’s plenty to be wary about. Keep your eyes out for transaction fees when weighing different balance transfer offers. Also, avoid cards that charge large fees.

Fees for Transferring Credit Card Debt from Card to Card

You will find that most of the offers you receive include the option to transfer balances from one account to another. There are sometimes hidden costs associated with these transactions, however. You may think you are being rewarded with low introductory rates on any new purchases you make with the card when transferring those balances. The cost to you, however, may be more than you think it will be. Well, after the “limited time” expires, usually three months to a year, the interest will go up by several percentage points. The application should tell you what the percentage increase will be. Make sure it is not more than the card from which you transferred your balance.

Ending Up With Two Credit Cards (or More)

Think about it. If you transfer the balance but you do not cut up the card from which the funds were transferred, you may be tempted to continue to use the old card. Now you have two balances to pay instead of one.

High-Penalty Fees for Late Payments

Universal Default

Many credit cards have a clause in the contract that says your interest rate will increase if you default on a payment—to any of your creditors! That’s right; credit card issuers monitor your credit report and if you pay anyone late they’ll jack up your rate. This is called universal default, and it’s yet another reason why you want to pay your bills on time to avoid costing yourself even more money.

Credit Cards: In the End

Of course, the best way to free up cash for the long haul is to eliminate credit card debt altogether. You’ll need to continue to pay as much as you can on those cards and make every attempt to pay more than the minimum payment. Adjust those spending habits to avoid running up huge credit card balances in the future. It’s all a matter of living within your means.

Remember, credit cards can be an important tool for service men and women and their families to cover such contingencies as emergency deployment and emergency family needs, such as car repairs. If you abuse them for other non-essential items, however, then they won’t be there when you need them.

In addition to credit cards, there will always be companies ready to loan you money. If you’ve gotten to the point where you’re considering a loan, do your research and ask for help. Talk to a financial counselor or look for reputable financial institutions that have been in business for many years and offer financial education alternatives.

There are some loans that you should avoid at all costs. Unlike credit cards, these five loan options can really never be used responsibly, and should always be considered bad debt.

Payday Loans

Also known as a deferred deposit service, these are loans that are issued against your next paycheck. They are short-term, small loans that typically range from $100 to $500. For the service, you will be charged a heavy fee (frequently 10 to 20 percent of the loan balance, or 400-600% Annual Percentage Rates) for a loan lasting only a few weeks).

Sometimes, you can get the lender to carry the loan for another payday. If this is done, they will charge you the fee a second time and the loan rolls over. If you roll the loan over three times, you will end up paying $60 to borrow $100. How much will that $60 you just lost cost you in the next pay period? “The cycle continues.” Once you start down this road, you can find your finances spiraling downward.

Payday lending laws vary from state to state. New England states have the strictest laws, and some southern and western states have no caps on how much lenders can charge in interest and fees. Here’s a troubling statistic: the national average annual percentage rate for two-week payday loans is 474 percent! Payday loans typically offer unconscionable rates and practices that negatively affect a service member’s financial situation.

Consumer organizations are pushing for a ban on expensive payday loans. Limiting the amount of interest a lender can charge or limiting the automatic rollovers would have a detrimental effect on their business and probably make payday loans unavailable to those who rely on this service.

If a payday loan seems to be the only option you have in a short-term emergency, the Federal Trade Commission recommends that you compare the loan fees, interest rates, and other costs of payday loans to other credit offers. Under the Truth in Lending Act, the cost of payday loans must be disclosed. Some financial institutions offer short-term loans that do not have these unconscionable rates and practices attached to them. Ask around in your local market for companies that offer these types of short term lending alternatives.

Pawnshop Loans

Pawnshop loans carry terms of one to four months and are secured by a piece of property, such as a ring, a watch, or a stereo—anything that has value. Interest rates vary from state to state and range from 2 to 25 percent per loan period. Remember that if there are any fees or charges then your Annual Percentage Rate will be increased. Almost all states require pawnbrokers to allow a grace period. The collateral is sold if the interest or loan amount isn’t paid off in the specified period of time. Think twice before you take your wedding ring, or heirloom to the shop. You might end up losing it if you can’t repay the loan.

Title Loans

These are secured by your car’s title. The lender determines how much you can borrow based on your car’s value, if there is a value. If you fail to make loan payments, even just one (read the small print), the lender can repossess the vehicle. Then you will have no car and you still may have to make car payments. Allowable interest rates on these types of loans vary from state to state.

High Loan-to-Value Home Equity Loans

This is a loan that is secured by the equity in your home but obliges you to pay more than your equity is worth. Some home equity lenders allow you to create a loan-to-value ratio of as much as 125 percent.

Getting a loan for more than your property is worth can be a gamble. Houses rarely sell for more than their fair market value. The interest rates on 125 percent loans are usually higher than less-risky regular home equity loans, too. And, to add insult to injury, all of the interest paid on the loan may not be tax-deductible. As you may know, one of the biggest advantages of purchasing a home is the tax break you get on the interest you pay.

To be “upside down” (owe more than it’s worth) on your house and to move is really frightening. And since military personnel move frequently, sometimes with little notice. Homeowners seldom think about all the things that can happen: divorce, relocation, or being forced to move before there is any equity in the home. These are all things that can happen to a service man or woman.

Advance-Fee Loans

This is when a company accepts a fee in exchange for a promise to find a lender who will make a loan or issue another type of credit. These companies claim a high success rate, even with borrowers who have a tainted credit history. If you pay the fee before checking into the lender and the offer, you risk getting taken. Fees, fees, and more fees! Lenders may require consumers to pay application, appraisal, or credit report fees, but these fees are never required before the lender is identified and the application completed.

Break The Debt Cycle

You love your military job and you take pride in serving your country. As a result, you want to keep this job. You want to be able to financially take care of yourself and your family, and you want financial stability for your future.

If you haven’t gotten yourself into credit problems yet, start with saying no; just say no to all of those things you don’t have to have! You have already read all of the reasons why you should keep from borrowing and using credit in a way that is irresponsible. Stick with your financial goals and your budget.

For some of you, unfortunately, you may feel like the information in this book came too late. You already have credit issues—now you need information on how to dig yourself out of debt.

Where do you go from here? You’re in the military. You need a plan, a process to ensure your mission’s success. And in this case, your mission is to get your financial stuff together!

Develop a Budget

The first step toward taking control of your financial situation is to do a realistic assessment of how much money comes in and how much money you spend. Start by listing your income from all sources. Then, list your “fixed” expenses (those that are the same each month), such as your mortgage payments or rent, car payments, and insurance premiums. Next, list the expenses that vary, such as entertainment, recreation, or clothing.

Writing down all your expenses—even those that seem insignificant—is a helpful way to track your spending patterns, identify the expenses that are necessary, and prioritize the rest. The goal is to make sure you can make ends meet on the basics: housing, food, health care, insurance, and education.

Spend Within Your Means

We can all agree that using credit is convenient; unfortunately, sometimes it’s much too convenient. You purchase goods and services without having to carry cash. Credit enables you to purchase any item now and pay for it in the future. Often that great-looking stereo, TV, and furniture is worn out or replaced long before your last payment is made.

To avoid temptation, you should also remove your credit cards from your wallet. (Some credit counselors even go so far as to recommend that you freeze them in a block of ice in your icebox. That should slow down the impulse buying!) Instead, carry a debit card or a charge card, which forces you to pay off the balance in full each month.

Not thinking about that long-term commitment and focusing only on the enjoyment of the purchase can result in a cycle of debt. You need to take responsibility for your situation and realize that your spending habits can be causing lots of problems. Use your budget as a guide, and make the decision right now that you’ll only buy things that you can pay for with cash—after you’ve covered all of your necessary expenses. Sure, this takes sacrifice; but your financial well-being is more important than spending beyond your means for things that you don’t need.

Pay-Off Debt, Any Way You Can

Experts recommend that you focus on the debt that has the highest interest rate and is costing you the most first. That said, if you’re the type who seeks immediate gratification, then you might want to start by tackling the debt with the smallest balance for the satisfaction of seeing one of your debts paid off. Many strategies could work for you—just pick one and stick with it! The most important thing is that you’re following a plan to reduce your debt.

Also, if you do have some money in a savings account, don’t withhold that cash and say, “I’ll pay these debts later when I have more money, so I don’t have to touch my savings.” The money you’re losing with interest and fees on your debt is much greater than what you’re earning on a savings account. You may be sacrificing your safety net for the time being, but chances are, if you’re in the debt cycle your savings are probably meager, and the reality is you’ll have much more money to save after you’ve paid off your debt.

Learn the Language of Lending

If you do need to access credit in the future, you need to know what to look for to make sure you’re getting the best deal available. To understand credit and debt, start by learning the most common terms. Below are definitions of some of the most common items you need to understand related to borrowing.

Interest Rate

Interest is money paid for the use of borrowed money. This concept affects how much money you will pay for using credit. Interest rates can be fixed or variable. A “fixed” rate means you will pay the same rate throughout the life of the loan. A “variable” rate, on the other hand, means that the rate will vary up or down. This interest rate is typically tied to the national “prime” interest rate. The written terms of the loan or credit card will indicate when and how often the interest rate can change. The interest rate on your debt varies with the lender, your current debt, your credit history, and the length of time of the loan.

Annual Percentage Rate (APR)

APR reflects the interest rate plus any fees or charges you will be charged and will be expressed as a rate of interest. Therefore, the APR contains all credit costs. The APR is intended to make it easier for borrowers to compare the cost of credit from one lender to another. In other words, it allows borrowers to compare “apples to apples” as opposed to “apples to pears.”

For example, two lenders may say that their interest rates are the same: 10 percent. However, the one lender’s fees may be more per year than the other lender’s. This difference would show up in the APR. Therefore, one lender’s APR may be 10.40 percent while the other’s may be 10.15 percent APR. All lending institutions are required to give you their APR.

Note: Both interest rates and APRs shown on applications are sometimes promotional. Read the disclosure—you may find that after a period of time, the promotional APR will expire and then it goes up.

Grace Period

A grace period is the time in days you have to pay your balance before the credit card company starts charging you interest or late fees depending on the type of transaction.

Balance Computation Methods

Fees

What are fees? Fees add up and can be very expensive. They include: · Annual fees (sometimes these will be waived if you have good credit)

· Late fees (these are typically a fixed dollar amount that is charged no matter how late—the cost of procrastination could be as much as $30)

· Late Charges (these are usually a percentage of the balance owed on the debt and are often based on how late you are)

· Fees if you go over the limit (these are usually associated with credit cards);

· Loan Origination Fees

· Finally, you may even be charged for closing the account

While you need to understand the above concepts, the biggest thing to consider is whether you can really afford the debt. Our world today makes accumulating debts as easy as filling in the forms, and the consequences can be very harmful to your financial future—so know what you’re getting into!

Get Your Credit Report

Now that you know the language of lending, you’ll want to get your credit report. Anyone who has used credit in the past has a “credit record;” a history of using credit and a log of how you pay or do not pay your bills. Your credit history will list personal information, which will include: credit card information such as what credit cards you have opened and whether or not they maintain balances; mortgage and other debt balances; and your payment history. It will also include all of the inquiries, which reflect each time you have applied for new credit, or the names of creditors and other “authorized” parties who have requested and received your credit report.

limits as a means of ensuring the loan is appropriate for your income and financial stability. You will be charged a higher interest rate or set lower credit limits based on the information they see.

Consider having your credit report examined by a financial professional to help you understand what your credit report means and how you can improve it. Maintaining your credit rating is a key to your financial success. Also, keeping track of your credit history with the credit bureaus can help you combat identity theft, which is discussed below.

Understand Bankruptcy

Since lenders make it very easy to accumulate debt, chances are you will find yourself in over your head in debt at some point in your life. At this point, you might be asking yourself: what is bankruptcy and am I candidate?

Bankruptcy is a legal remedy and, as such, only an attorney can properly advise you on the process. For most people though, the decision to even speak with an attorney about bankruptcy is based partially on facts, partially on emotions, and partially on a person’s views of his/her future.

As in so much of life, there are no hard and fast rules to determine if you are a candidate for bankruptcy. Everyone’s financial/emotional/future situation is different. One person with $25,000 in debts can sleep at night and doesn’t worry. A different person with that same amount of debt stays awake at night and worries all of the time. The situation affects their operational readiness. Those individuals in such a situation may feel that they have no other choice but to declare bankruptcy. Others may see great future opportunities for themselves and find ways to clear the debts, certainly ways to clear their “past due” situations.

Bankruptcy can affect your promote-ability, new job applications, renting a new apartment, insurance, and your ability to make major purchases. Do you see your life as on an upward trend or a downward slide? What are your goals for the next two to ten years?

What is most important to keep in mind is that bankruptcy should be used with caution and with a full understanding of the consequences. Always consult your attorney or other financial professional before making decisions regarding bankruptcy.

Seek Credit Counseling

If you a need to talk with someone who can help you with your credit problems, you may choose to use a credit counseling agency. Okay, read this carefully! There are basically two kinds of credit counseling services: 1) those that are trustworthy and do all that they can to help you for reasonable fees or no fees; and 2) those that make promises they frequently cannot keep and that attempt to get rich off your terrible situation through fees and the types of payment arrangements they make. For the sake of further discussion, we will label these as “Trustworthy” and “Avoid At All Costs” credit counseling agencies.

Trustworthy Agencies

If you choose to use credit counseling, here are some questions that are recommended by the National Foundation for Consumer Credit:

· Is this agency a non-profit organization?

· How much will their services cost?

· Are their services confidential?

· Will they devise a plan that is tailored to fit your needs?

· Are their counselors certified?

· Will your funds be protected?

· Is the agency accredited?

Most debt counseling agencies are nonprofit organizations that get much of their financial support from the credit card industry. They offer numerous services, including debt-management plans. When you enroll in one of these debt-management plans, you write one check a month to the agency and the agency pays your creditors for you. In a typical debt management program, a card issuer will charge lower interest rates, will eliminate late fees, and will lower monthly payments. In addition, you will get fewer calls and letters from bill collectors. Debt counseling agencies obtain their operating money by receiving a percentage back from client’s payments to each creditor.

These organizations usually only handle “secured credit” obligations but will occasionally take on some “unsecured” credit, such as credit card companies. This is how it works: They will mediate a repayment schedule for you based on a 3–5 year time frame. Be aware that this service can cost you money. Even though they do reduce your required monthly payment, they may not reduce their finance charges. What does this mean? It means a 48- or 60-month contract will be increased by many months and the total financial charge may be much higher than the original contract terms. These organizations may also add additional finance charges for the increased term.

Make sure that the debt management or credit counseling firm answers all of your questions and that you have a firm understanding of how the process works. Most importantly, find out what it will cost you. If you do not get the answers to your questions or you do not understand what’s going on, don’t sign up with that company.

Just remember, this is a time to be cool under fire. This is not the time to panic and make a decision that costs you more money and delays in getting your problems fixed. View this as a military “situation.” Meet with the agency’s personnel, gather information, evaluate that information, and then make a decision that is best for you. No intimidation, no fear!

Avoid-At-All-Costs Agencies

If you trust the wrong company, getting help could be downright dangerous to your wallet and your credit rating. A lot of credit counseling and debt consolidation companies are looking to make a quick buck by preying on stressed-out, financially vulnerable consumers. Some companies are guilty of merely shoddy service and sky-high fees. Others are just scams.

Why are these fly-by-night companies opening outside every base in the United States? As a nation, we are wrestling with a $723 billion in credit card debt. Toss in an economy that is slow and it comes as no surprise why so many of these individuals are turning to these types of companies for help.

Be aware that some agencies pocket the first month of credit payments for themselves. So, right off the bat, you’re a month behind. The result? Your credit accounts get slammed with late fees and penalty interest rates. Instead of being current, you’re a month behind. Most consumers are not aware of how some of these agencies work. If it’s in the fine print, it’s the consumer’s responsibility to read it. Read everything!

That’s on top of the hefty upfront fee you pay the agency. That means you pay two months’ worth of creditor payments in a single month. That might prove impossible for someone who is already having trouble paying his or her debts in the first place.

By employing the services of some of these agencies, your financial situation can continue to get worse. Let’s say you are paying minimum payments on your Visa or MasterCard that, on its own, will take you at least ten years to pay off; then, throw in the renegotiated payment and you could end up paying off your mortgage before you get your credit card paid off.

Choose wisely. Complaints against debt consolidation companies are at an all-time high according to the Council of Better Business Bureaus.

The Bottom Line

If you find that your debts are getting out of hand, the last thing you want to do is ignore them. Hiding your head in the sand will not make the bills go away. The longer you let them go, the worse it gets. Sitting down to discuss things with your lenders is the responsible thing to do.

Most lenders would rather know there is a problem and help you than have you be unresponsive to their calls. If you talk with them, they at least know you will try to solve the problem. Also talk to your financial institution to see if they have any education programs to help you better understand your situation.

Identity Theft

The only thing worse than running up those credit cards, taking out those loans, and getting yourself into terrible money trouble is someone else stealing your identity and running up bills in your name.

With your name and Social Security number, your birthday, and other personal information such as credit card numbers, insurance information, and bank account numbers, such thieves will have the ability to establish new credit, to run up debt, or to take over existing accounts. This will not only ruin your credit but it could leave you with bills you didn’t run up. It will likely also cause many headaches in the process.

Protecting your personal information is vital. Did you know that many businesses share or sell your information without knowing how it will be used? Your bank’s or insurance companies’ “Privacy Statement” can stop such organizations from selling your name and personal information.

When shopping online or by catalog, you should instruct these venders not to sell your information to other venders. A good indication that your information is being sold is those six additional catalogs you receive in the mail right after you place that order.

Identity theft is a white-collar crime and most police departments are not equipped with the tools necessary to investigate each case. The bad news is that these cases are not usually solved. In fact, prosecution occurs less than 10 percent of the time. Most times, these criminals are not working alone. As a group, they steal several different identities at a time and leave behind an untraceable trail.

If this happens to you, the result will be a ruined credit history and a lot of time trying to get your finances in order. The average cost of identity theft tops $18,000 and does not include cases where the thief retains a job and where employers incur additional costs.

15 Tips to Avoid Identity Theft

1. The key to your personal information is your Social Security number. As such, it is the prime target of criminals. Guard it well.

2. Monitor your credit report annually since it will contain all of your personal information, such as your Social Security number, your current and prior employers, and a listing of all your open and closed account numbers.

3. Keep all receipts and statements in a safe place, and shred them when you are ready to dispose of them (this includes “junk mail” credit offers).

4. Remove your name from the marketing lists of the three credit reporting bureaus to reduce the number of pre-approved credit offers you receive.

5. Add your name to the lists compiled by the Direct Marketing Association’s Mail Preference Service and the Telephone Preference Service.

6. Do not carry extra credit cards or other important identity documents, except when needed.

7. Photocopy both sides of your license and credit cards so you have all the necessary information if your wallet or purse is stolen.

8. Do not mail bill payments and checks from home. They can be stolen from your mailbox. Take them to the post office instead.

9. Never print your Social Security number on your checks.

10. Keep the Social Security Earnings and Benefits statements sent to you once a year around your birthday and check them for fraud.

11. Review all charges on your credit card statements before paying them.

12. Cancel unused credit card accounts.

13. Never give your credit card number or personal information over the phone, unless you have initiated the call and trust that business.

About Essential Knowledge

Essential Knowledge is an independent financial education company. We offer specialized education about personal financial management through online programs, books, tools and resources, workshops, and financial counseling.

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Basic Budgeting

Personal Finance for Military Families

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Personal Finance for Military Families

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Personal Finance for Military Families

Insurance and Taxes

Personal Finance for Military Families