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Managing Credit   

Revision Date: 11/11
Maria Pippidis

The use of consumer credit has become a major component in the management of money. Consumer credit should be used responsibly and effectively. Before individuals and families can begin to manage their credit properly, they should answer the following questions:

  • Can I afford additional debt?
  • When can I afford additional debt?
  • Should I consolidate my debts?
  • What happens if I cannot pay my bills?
  • How do I know if I am abusing credit?

Guidelines follow to help answer these questions. Case studies will be used to explain the guidelines.


Can I Afford Additional Debt?

Suppose that you want to buy a car but you do not have the cash to pay for it. You need to decide whether you can afford to borrow the money now or if you should wait until later to buy the car.

Use the 20 percent rule to determine whether you can afford to borrow the money. Your total debt (except for your home mortgage) should not exceed 20 percent of your monthly income after taxes. For example, if you bring home $1,211 a month, you can afford credit payments of $242 a month according to the 20 percent rule ($1,211 x 0.20 = $242). If your loans and credit card payments exceed the $242 amount, you probably will begin to feel yourself in a financial pinch.

By making the calculations and comparisons below, you can determine the amount of credit you can afford.

Compare lines 3 and 4. If your present monthly obligation is greater than your maximum acceptable debt limit, you cannot afford the car. If your present monthly debt obligation in addition to the monthly car payment is less than the maximum acceptable debt limit, you can afford the car.

Case Study

Since their marriage, John and Mary have been going weekly to a nearby self-service laundry. This routine is inconvenient. They are considering the purchase of a washer and dryer since their apartment has washer and dryer connections. They do not have the cash to pay for the new appliances. Can they afford to borrow the money?

John is employed with a local manufacturing firm and takes home $1,040 a month. Mary is a part-time editor and takes home $496 a month. Their combined monthly take-home pay is $1,536. Their present monthly expenses are listed in Table 1. Their debt payment is $338.

John and Mary’s present monthly debt obligations are listed in Table 2.

By using the 20 percent rule, John and Mary are already exceeding their debt limit by $30.80.

In fact, John and Mary are exceeding their take-home pay with their combined expenses and debt payments.

They are spending $38 more than they make. That is why they had to go into their savings account to buy groceries last week. They certainly cannot afford to buy a washer and dryer now. They need to devise a plan to cut back on their daily living expenses and pay off some of their debts. They might increase their income by finding better paying jobs or Mary may choose to work full time.

Table 1. Present monthly expenses

When Can I Afford Additional Debt

You can afford additional debt if your monthly credit payments will not take more than 20 percent of your income. If your credit payments currently take 20 percent or more of your income, you may want to set up a timetable to help you decide when you will be able to borrow more money. You can do this by listing your debts, total owed on each, monthly payments, number of payments left, and date they will be paid in full (Table 2). Then, list the months in which payments will be made and the monthly payments due (Table 3). When your monthly debt payments have decreased to a point where the addition of a new payment will fit within the 20 percent rule, you can safely add the new debt. Let us examine John and Mary’s situation.

To determine when John and Mary can afford to buy a washer and dryer, refer to Tables 2 and 3. After July, the minimum monthly payments will be reduced to $328 a month. After August, the minimum monthly payments will be reduced to $298 a month. By October, the monthly debt payments will be $247. By January next year, the payments will be $204.

John and Mary determined how much debt they could afford. Now, they know when they can afford to purchase the washer and dryer. Their next step is to shop for the best buy on a loan to finance those appliances.

Should I Consolidate My Debts?

If your monthly debt payments are overwhelming, debt consolidation may seem like an easy solution. But before you decide to consolidate, consider the following questions and steps:

Step 1: What is the total amount I owe for the debt obligations I want to consolidate?
(Table 4.)

  1. List each creditor and amount owed to each creditor.
  2. Beside each debt, write down the amount of your monthly payment.
  3. Next, figure out how many payments you have left for each debt.
  4. Finally, write down the month and year when you expect to pay off each debt (Table 5).

Step 2: Contact a minimum of three lending institutions to compare the cost of borrowing. Ask the following questions when comparison shopping for the consolidation (Table 6).

  1. What is the annual percentage rate?
  2. What is the total cost of the loan in dollars?
  3. How long will it take to pay back the loan?
  4. What are the number, amounts and due dates of payments?

Step 3: Select the loan that is the best buy and compare it with your situation. Put the figures together on a chart so you can visualize whether you should consolidate or make the payments without consolidating (Table 7). Compare the cost of consolidating and not consolidating; then ask yourself this questions:

  1. If I do not consolidate, what will my monthly payments be and for how long will I be making these payments?

Look at a case study and apply the guidelines for deciding whether or not to consolidate.

Case Study

Susan brings home $784 a month from her job as a county employee. She shares an apartment and her portion of the rent is $200 a month. Her loan obligations are $194. She owes the debts listed in Table 4.

Her total monthly loan payment of $294 is $137.20 over her maximum acceptable debt.

$784 x 0.20 = $156.80
$294 - $156.80 = 137.20

Susan is wondering if she should consolidate her bank and student loans and a department store bill so her monthly payments will be lower than $104 ($41 + 33 + 30 = $104). What should she do? Should she consolidate or not?
First, Susan needs to make a table and include the following items describing the loans she wishes to consolidate:

  • Her creditors’ names.
  • Total dollars owed to creditors.
  • Amount of monthly payments.
  • Number of payments left to be paid.
  • Dates paid in full.

The debts to be consolidated appear in Table 5.

Now she needs to decide what is the best alternative for repaying the debt. If she chooses to pay off her debts without consolidating, she will pay back $104 for 12 months, $74 for the next 8 months, and finally $56, assuming that she does not borrow any more money. In 22 months, she can repay the $1,896 (Table 7).

Next, she needs to shop around to decide how much it would cost for her to consolidate the three loans. The cost of loan consolidation at three different financial institutions is listed in Table 6. If she consolidates by borrowing from the first bank, she will pay $99 each month for 24 months and end up paying a total of $482 more than if she had not consolidated.

Consolidation will lower her monthly payments by $5 for 12 months. In the next 8 months she would pay $99 if she consolidates and $74 if she does not consolidate. Differences in how much Susan will have to pay if she chooses to consolidate rather than not to consolidate are shown in Table 7. Consolidation would extend her payments 3 months and cost an additional $482.

a $104 = $41 + 33 + 30; to be paid for 12 months until department store is paid
b See Table 6, cost of consolidated loan based on Bank 1.
c $74 = $41 + 33; to be paid for next 8 months until student loan is paid.
d $56 = amount left to be paid. This amount can be paid in full, or Susan can pay $41 one month and then pay the $15 balance the next month.

What Happens if I Cannot Pay My Bills?
If you are experiencing financial difficulties, contact your creditors immediately and explain why you are unable to pay. Most creditors are willing to work with you in developing a revised payment schedule to fit your circumstances. Do not ignore your creditors. A number of things will happen if you do.

The process of collecting debts varies considerably from one creditor to another. It will depend on the creditor’s policies and accounting procedures. Some creditors take action against late payments if you are a few days late. Others do not send late notices until you are at least 30 days late.

If you get 60 days behind, you generally will receive another request for payment. At the end of 60 days, some creditors will turn the debt over to an attorney or collection agency to collect the
late payments. Some creditors have their own representatives who collect debts. If a creditor turns your account over to an attorney, expect an additional cost in attorney fees.

After a period, if the debt has not been collected, you can expect some type of court action by the creditor. The creditor will file a suit in small claims court, magistrate court or state court in an effort to get the court to make you pay your bill. The court’s decision is called a judgment.

If the court rules in the creditor’s favor, you can expect your wages to be garnished or your assets to be taken (attached). If the court rules that your wages be garnished, the creditor notifies your employer of the garnishment action and about 15 percent of your wages will be sent to the creditor unless this amount would leave you with a paycheck of less than 30 times the Federal minimum wage; then no more can be taken than the amount of money that exceeds the Federal minimum wage. This does not apply to garnishing money for alimony or support of a dependent. Also, creditors can legally attach the assets in your checking or savings account up to the value of the court judgment. Your personal property can be seized and sold.

The creditor may already have or can obtain the legal right to repossess the property. This means you lose the car, truck, appliance or other item for which you borrowed the money.
Frequently, the creditor sells the property for less than the amount you still owe on it. If the item does not sell for enough money to pay off the loan, the creditor will file another suit for a deficiency judgment to make up the difference between what was owed and the sale price of the item.

For example, assume you borrowed $2,000 to buy a stereo. However, you missed payments and it was repossessed. If the loan balance were $1,750 and the stereo sold for $1,000, you would be sued for the remaining $750. If you failed to pay the amount of deficiency judgment, your wages could be garnished or the creditor could seize other possessions for the amount of the judgment.

Do not ignore the suit. Contact an attorney immediately. If you fail to file an answer to the suit and fail to appear in court, the creditor will win the suit by default. If you appear in court, you possibly can work out an acceptable plan with the creditor. If you do not appear in court, you cannot defend yourself against the creditor’s claim.

How Do I Know if I Am Abusing Credit

If you find yourself in the position of considering loan consolidation, you may be headed for financial difficulty. The following are signs of credit abuse:

  • More than 20 percent of your take-home pay is used for credit payments, excluding home mortgage.
  • The second salary in your household is used exclusively to pay debts.
  • You and/or your spouse are dishonest about credit use.
  • You do not think of credit as a form of debt.
  • You use credit cards impulsively.
  • You do not pay your bills on time.
  • You pay only the minimum amount due on your charge accounts each month.
  • You have defaulted on a payment or your rent.
  • Your anticipated pay raise is already committed to paying debts.
  • Your debts exceed your assets.
  • You do not know how much you owe.
  • You have taken out a loan to consolidate your debts.

The mismanagement of credit creates many problems. Become familiar with the danger signs of credit abuse. If any of these signs apply to you, you are probably headed for financial difficulty. Several options are available to help you manage financial problems. Getting Out of Debt, provides information on some of these options. It includes a step-by-step process for setting up a debt repayment plan, and information on credit counseling services and court provisions such as bankruptcy. You can get this fact sheet from your county Extension office.

Kent County Extension Office, 697-4000
New Castle County Extension Office, 831-1239
Sussex County Extension Office, 856-7303

Adapted by Maria Pippidis, University of Delaware Cooperative Extension from Communicating About Money, by Mary Stephenson, University of Maryland Cooperative Extension and Money Mechanics: Communication, by Cynthia Needles Fletcher, Ron Jones and Jane Schuchardt. Iowa State University Cooperative Extension.

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