Smart Consumer Credit

With Back-to-School, Thanksgiving having just passed and the Holiday Season upon us it would be smart to understand the credit choices that we have in the world of credit and loans.

You have probably heard or used the following phrases: “Charge it!”, “Cash or credit?”, “Put it on my account”, etc. These phrases indicate that the use of credit is a fact of life and therefore an integral part of personal financial planning.

Q. What are the basic types of credit?
A. Credit is the ability to purchase goods or services in exchange for a promise to pay at a future date. So, when you borrow money, the lender provides credit to you and you agree to repay the loan in the future. Therefore, credit can be defined as money owed to another in accordance with an agreement.

• The person who borrows the funds is called the debtor. The person to whom the funds are owed is called the creditor. The main purpose of using credit is to:
• Satisfy an immediate need on the understanding that it must be paid for in the future.
• Increase the value of assets, such as real estate or investments on the basis that the return on investment will exceed the borrowing costs.

Q. What are the types of credit available?
A. There are many types of credit available to consumers in Canada. Types of credit can be categorized as follows:

• Consumer financing or credit: borrowing money to purchase consumer goods or services.
• Mortgage loan: borrowing money to finance the purchase of real estate.
• Investment loan: borrowing money to invest in securities or for business purposes.

Q. What is consumer credit?
A. Consumer credit is the extension of credit to individuals and families for personal or household use based on a risk assessment of the person’s ability, and willingness, to pay their bills when they become due. The following types of consumer credit financing are available in Canada:

• Open Account Credit: This is by far the most common type of credit available to Canadians. Here, products or services are provided to consumers in advance of any payment. For example, in April you pay a bill for hydro that you used in March.
• Charge Card: A charge card generally allows you to charge purchases, usually with no pre-set spending limit, on the condition that you pay off all items charged to your account as shown on the monthly statement due date . If you do not pay the balance owing in full, interest will be calculated on the amount owing, generally at a high interest rate (often as high as 30%).
• Credit Cards: In comparison to a charge card, a credit card will allow a cardholder to carry a balance provided a minimum monthly payment is made or pay off the balance in full. Credit cards have a specified credit limit. The minimum monthly payment is usually the greater of 3% to 5% of the outstanding balance or a fixed dollar amount. Depending on the type of credit card you have, interest charges can be relatively high.

Q. What are the three categories of credit cards and how does it affect me?
A. There are three classes of credit card issuers who provide credit cards with different characteristics.

A summary of issuers and the features associated with their credit cards follows:
Financial Institutions: Banks, trust companies and credit unions usually issue credit cards. Most cards have annual fees while some “no frills” cards do not.

• If the entire balance (purchases, cash advances, etc.) is paid in full by the payment due date, no interest is charged.
• If the entire balance (purchases, cash advances, etc.) is not paid in full by the statement due date, interest will be charged and calculated on the entire balance (i.e. while interest is always charged on cash advances, the interest-free grace period for any new purchases will no longer apply) from the transaction date.
• Cash advances usually appear to be an attractive option; however, interest accrues from the moment you obtain the cash advance.
• Retail Stores: Retail store credit cards usually have no annual or transaction fees. However, the annual interest rates charged could be higher than a card issued by a financial institution, unless the retail store card is actually issued by a financial institution on the store’s behalf.
• Gasoline Retailers: Credit cards issued by gasoline retailers also generally have no annual or transaction fees. Interest rates on these cards are high but may be slightly lower than retail store cards.

Debt management is maintaining control of your expenses to help enhance both lifestyle and net worth. When you use credit, you satisfy certain needs today but will have an obligation to pay for this convenience in the future. While credit is a valuable financial planning tool, it requires careful management. When used effectively, credit can help you make purchases sooner than if you had to pay with the cash you had on hand at the time of the purchase. When misused, it can result in default, loss of creditworthiness and in some cases, bankruptcy.

Talk you your advisor today about your credit and how it fits into your financial plan.