Financial Thinks To Keep in Mind
A Credit Card is Not Free Money
A credit card is a useful tool in your finance toolkit, but it’s not free money.
When you purchase something with your credit card, you are borrowing money from the bank. If you don’t give that money back in time, the bank is going to start charging interest on your balance.
This debt can build up and become a monster if you don’t pay off your balance every month.
However, if you use a credit card responsibly and pay off the balance every month, it’s a good way to start building credit. Most credit cards also have other benefits such as rewards points, cash back, or travel points.
So, should you have a credit card? Well, it depends.
If you’re capable of paying off the balance in full every month, then you should have no problem managing a credit card and staying out of debt.
PS: If you are going to use a credit card, you should monitor your credit score & credit report regularly with a free tool like MoneyTips (or Borrowell if you’re in Canada).
One last tip: Treat your credit card as a debit card. Pay it off in full every day if you have to. I try to pay off my balance every couple of weeks so that I don’t forget.
Stay Out of Bad Debt
Debt means you owe someone money, and if I’ve learned anything from gangster movies, you NEVER want to owe someone money.
However, not all debt is necessarily bad debt.
So, what is bad debt?
Bad debt is any debt that’s acquired through purchasing something that’s going to lose value and generate zero revenue.
Some examples of bad debt would be credit card debt or an auto loan.
What is good debt?
Good debt is the opposite of bad debt. Good debt is acquired so that you can purchase something that is going to benefit you financially in the future. That means it’s either going to generate income or allow you to make more money in the future.
Good debt usually has a lower interest rate as well. Here are some examples of good debt:
Since student loans typically have a very low interest rate and going to school can increase your pay as an employee in the future, student loans can be considered good debt.
However, if you’re going to college just because you don’t know what else to do after high school, that’s probably the wrong move. You could end up wasting a lot of money studying a field that you don’t even enjoy. Then you’ll be stuck working a job you hate to pay off your student loans. Not fun.
This one’s a tricky one, but mortgages are generally considered good debt. They are usually long-term loans with low interest rates, so you’ll still have money freed up for investments and such. The interest from mortgages is also tax deductible, so that’s a bonus.
In the end, it’s up to you to decide whether purchasing a home is the right move, as the value of a house will not always rise as some people think. You’ll also have to add in the expenses of property tax, utilities, and home insurance.
There are a lot of online business ideas you can start on the cheap these days, but a small investment can also go a long way in certain endeavors. Business loans are considered good debt because they are put towards something with the goal of increasing your net worth.
Have an Emergency Fund
If you lost your job tomorrow would you have enough money to live off while you look for a new one? If not then you’re not alone.
This study found that although Americans are doing a better job at saving, around 24 percent of them (57 million people) don’t have an emergency fund.
Now I don’t want to be a negative Nancy or a Debbie downer, but emergencies happen all the time. They may not happen to you, but it’s always good to be prepared.
You can’t predict an emergency, but you can prepare for one.
The best way to do so is to set up an emergency fund of 3-6 months living expenses. That means if you lost your job tomorrow, you’d be able to live off your emergency fund for 3-6 months while you look for a new one.
Here are some common financial emergencies:
- Job loss
- Car problems
- House repairs
- Natural disaster
- Medical or dental expenses
Still not convinced that you need an emergency fund? I wrote a story to show you how important having an emergency fund is:
The Story of Jimmy
Jimmy is an optimistic guy who makes $2,000/month and pays $1,500/month in expenses. The leftover $500 he uses as pleasure money.
Jimmy doesn’t think anything bad will ever happen to him, so he doesn’t think he needs an emergency fund. He’s done fine all these years without one, right?
Jimmy goes into work one day and is told he’s being let go because the company has gone bankrupt. Sorry, Jimmy.
Jimmy is shocked, but he’s still optimistic. He’ll just put his expenses on his credit card while he looks for a new job. He’ll have to live without his $500 pleasure money for a bit, but he’s okay with that.
Jimmy works hard to find a new job and 2-months later he’s hired. It pays a bit less at $1,750 a month, but it’s better than nothing.
He’s now racked up $3,000 in credit card debt. Since his new job pays less than his old one, he’ll only have $250 left each month after paying for the necessities.
With $3,000 on his 15% APR credit card, it will take him 14-months to become debt free , and he’ll pay about $270 in interest . Keep in mind Jimmy would have to live without any pleasure money for over a year to pay off his debt at this rate .
If Jimmy had just set up a 3-month emergency fund, he wouldn’t have had any debt at all, and he would still be able to do fun stuff.
Moral of the story:
Don’t be like Jimmy. Set up an emergency fund. You probably didn’t need that silly story to convince you, but it was fun to write.