Financial Literacy Guide

Debt refers to money this is owed or due. This money is typically borrowed from a bank. People often borrow money for the purposes of attending college or purchasing a car or house. Debt can also accrue by way of credit cards – more on that later. All borrowing comes with an additional cost known as interest. Interest is a percentage that is charged and added to the principle loan amount – interest allows the bank to make money. If you need to borrow from the bank, it’s important to choose a loan that has a lower interest rate. If you opt to use credit cards, be aware of interest rates. Debt is often times unavoidable; however, your debt must be managed. Until you are debt-free, it will be impossible to experience full financial freedom. Don’t try and keep up with your friends or colleagues by purchasing a new car or spending extravagantly on vacation. Live within your budget – you will be happy that you did.

A credit profile or credit report is data that is available on every consumer in the United States. There are three major reporting agencies – Equifax, Experian, and TransUnion. Federal law allows you to request a free copy every 12 months from each of these agencies. At the time this publication is being printed, these agencies are allowing consumers to request a free credit report on a weekly basis.

Reviewing your credit profile often will allow you to identify discrepancies and monitor your financial health. Knowing your credit score and the information contained on your profile will be helpful should you need to borrow money in the future. Prior to checking your credit, a bank or lender must obtain your written or electronic authorization.

You can make a positive impact on your credit profile by paying your bills on time and carefully utilizing your use of credit. If you are not paying your bills on time, overusing credit cards, and borrowing too much money, your credit will be negatively impacted. 

Sure, you are interested in borrowing money from the bank…but, that’s not exactly what we are talking about. Interest is charged on a loan or credit card balance and it allows the bank to make money. When choosing a loan, you’ll often see two types of interest rates:

Fixed interest rate

It stays the same for the duration of the loan and will not fluctuate. Locking in a competitive, low interest rate at the beginning of a loan is a great strategy for making sure you aren’t surprised later.

Variable interest rate

It fluctuates based on the economy and a variety of benchmarks used by financial institutions to set their rates. When possible, avoid loans with variable interest rates. There is too much uncertainty, and this could cause issues as you attempt to fit your debt into your monthly budget.

John needs reliable transportation and he has always wanted an SUV. He has been seeing commercials and recently stopped by his dealership to take a look at a brand-new vehicle. After hearing about the vehicle from the salesperson, John was ready for a test drive. The test drive went well and he was ready to purchase the vehicle. John is a recent graduate with a great salary – this was going to be his reward for graduating and securing a job in his field. John doesn’t have an extensive credit history; however, he was able to get financed because he pays his bills on time and has a good income. At the end of the day, John financed $45,000 at a 14 percent interest rate. John’s monthly payment is $903.33 for the next 72 months. The total cost of John’s vehicle after 72 months is $65,040.10 (that’s the principle plus interest).

Sarah needs reliable transportation for her new job. She’s a recent graduate working in her field with a great salary. Sarah understands that she doesn’t need a brand-new car; however, reliability is important. Sarah recently stopped by several car dealerships after comparing prices online and researching a handful of vehicles. She finally settled on a car that was few years old with low mileage. Most importantly, the car received great reviews for reliability. Sarah took the car for a test drive, and decided to make a deal. Sarah’ situation is similar to John – not much credit history, but she pays her bills and has an above average income. Sarah financed $12,000 at a 9 percent interest rate. Sarah’s monthly payment is $298.62 for the next 48 months. The total cost of Sarah’s vehicle after 48 months is $14,333.78 (that’s the principle plus interest).

Here are some observations:

• Both of their situations in regard to employment status were similar.
• John had a specific vehicle in mind; Sarah wasn’t locked into a specific vehicle.
• Sarah researched reliable vehicles; John’s only research was watching commercials and a test drive.
• John financed a new vehicle at a higher interest rate and Sarah financed a used vehicle at a lower interest rate while still getting a reliable vehicle.
• John had to extend his loan to 72 months so he could hopefully afford the payment; Sarah is financed for 48 months with a reasonable monthly payment that will fit into her budget.

More to come on budgets later in this guide!

We can’t talk about financial literacy without addressing credit cards. When you are approved for a credit card, a bank is crediting you with funds that can be used to make purchases. You can use your credit card for almost anything – reoccurring monthly expenses, groceries, clothing, and almost anything else you can imagine. It’s important to note that you can’t make payments on your vehicle loan, mortgage, or other types of installment loans using a credit card.

Credit cards can be a convenient tool for building your credit profile and, when used responsibly, can actually help raise your credit score. It’s also important to know that excessive use and failure to make required payments is one of the quickest ways to damage your credit profile. Prior to opening a credit card, you should fully understand the terms and conditions. Additionally, be on the lookout for annual fees. When in doubt, contact the company to ask questions prior to submitting your application. When you submit your credit card application, you are authorizing the company to check your credit report.

Many companies offer incentives for using their cards – cash back, airline miles, etc. These perks are nice, but they should not be the driving force that determines whether or not you are using your card. In most cases, credit card usage should be limited.

Installment loans are typically used to finance a large sum of money over an extended period time. Depending on the type of loan, the term will vary. Vehicle loans, mortgages, student loans and personal loans are examples of installment loans. The item you are attempting to finance will determine which type of installment loan is right for you. There are pros and cons to each type of installment loan – again, it’s important to read the fine print and fully understand the terms of loan, including interest rates and origination fees, before signing.

Installment loans can be secured or unsecured – it will depend on the type of loan that is appropriate for your situation. A vehicle loan or mortgage will use your automobile or home as collateral. That is, if you stop making the payment and can no longer cover the obligation of your loan, the bank will collect and sell the collateral to recoup their loss. In some cases (i.e. a personal loan), a loan may be unsecured. That is, you are not required to offer anything up front as collateral. These loans, of course, are riskier for the bank and will likely have a higher interest rate. 

You can reduce financial stress and be ready for emergencies with a healthy budget. Not having a budget is like driving with your eyes closed – eventually, you are going to crash. Creating a monthly budget doesn’t have to be difficult.

To get started, analyze all of your various streams of income – this will primarily be the wages from your source of regular income. Next, record your fixed monthly expenses and categorize them (i.e. loan payments, credit cards, subscriptions, utilities, etc.). Deduct these fixed expenses from your monthly income. Once you have analyzed your fixed expenses, it’s time estimate other monthly expenses that can vary month-to-month (groceries, gas, etc.). These are items that are essential to daily living; however, the price can fluctuate – in general, it should be easy to estimate these items based on your habits. Once you have recorded these items, deduct them from your remaining monthly income.

If you have money remaining, nice work! You have enough money to cover your monthly commitments. The remaining funds, sometimes referred to as discretionary funds, can be used to build up your savings. Having money in savings for an emergency situation is an essential goal to achieve. Discretionary funds can also be used for dining out, visiting the movie theatre, updating you wardrobe, or anything else that will improve your quality of life. If you don’t have enough money remaining after your monthly commitments are covered, you may need to explore reducing your commitments and/or creating an additional income stream to support your budget.

In general, it’s important to take a hard look at your monthly commitments and reevaluate your budget every month. Adjusting the monthly commitments you can control (i.e. subscriptions, cell phone plan, Internet, cable, etc.) can be an effective way to lower your bills.