Monday, August 07, 2006

About credit cards and budgeting

Credit cards or what I like to call "plastics" can come quite handy when you don't have lots of cash on you. It is important to know that credit cards are not money. It is more of a loan that you must pay back. If you don't pay the minimum balance, which is usually around $10 to $30/month, this will be reported in your credit report and will stay there for a very long time. Not only would it be reported, your credit score will go down as well, which is used by financial institutions and lenders to see what interest rate you qualify for.

There are two types of credit cards: fixed credit and revolving credit.

What is fixed credit? This means whatever you buy today, you must pay off the whole balance by the end of the month.

What is revolving credit? This means as long as you pay the minimum balance on your credit card, you can continue to use the credit card for next month. Any remaining balance on your credit card will be charge an interest. This is the most common used form of credit cards.

You might of heard or read the news that consumer debt is in the trillions. This does not include mortgages, which is too big of a number to say. My theory on how this happen is that Americans are spending freaks. We like nice things and we sometime go overboard that is well over our spending limit. If we max out one credit card, we can always apply for more. While spending is good for the economy, spending more than what you make is really bad for you because you are going to find yourself to be in debt for a very long time.

To avoid putting yourself in big debt, spend what only you can afford. Make a budget or put up a spending limit. To do this, figure out how much money you make each month. Then deduct bills you have to pay such as mortgage, utility bills, maintenance, etc. Then deduct how much money you want to save toward retirement. And from that, this is how much you should spend and divide that by 4 or 5 to see how much you can spend each week.

So here's a typical example on how a budget should look like (you can add more if you want to the list):
Let's say you make $42,000/year. Divide that by 12, that's $3500/month.
You have a mortgage bill of $950/month,
utility bills (phone, electric, water, heat oil/gas) of $400/month,
maintenance (such as your car, including gas) of $200/month,
and insurance (life, car, home, health) of $1000/month.
This leaves you with $950/month to spend. Let's say you want to save 10% of that ($95), so you now have $855/month to spend on food, clothing, supplies, and other things.

If you decide to buy an expensive item such as $2000 TV, then deduct your monthly spending by whatever percent you like (such as 20%) so that you can pay off this $2000 TV faster. If you finance the TV where you don't have to pay it for another year, then open a 12 month CD and then use it to pay off the TV.

The goal in life is to not be in debt for a long time and at the same time be able to save for retirement. I wish you all best of luck on creating a successful budget and on your goal on reaching financial independence when you retire.