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Unfortunately, debt has earned a rather negative connotation over the years, and it is mainly due to people using it irresponsibly. The good news is however that if it is understood and used maturely, it can be used as a financial superpower.
Types of Debt and the Role of Banks in Financing
There are two types of debt, short-term debt and long-term financing. Short-term debt is when an individual makes use of a credit card to pay for certain expenses. This is not a problem, as long as the debt is repaid before it starts accumulating interest which is usually after 20 days to a month.
Long-term financing is also an important tool to assist individuals in affording expensive assets such as property, vehicles, education and business interest. These assets could not otherwise be afforded or obtained but are important investments.
Commercial and retail banks play an important role in facilitating the flow of money and capital in an economy. Individuals and businesses that have excess capital deposit their money in a bank with the goal of earning interest. Individuals and businesses in need of capital will loan this capital from the bank. After receiving the loan, they are obliged to pay the bank interest over the period that the capital needs to be repaid.
Take Advantage of your Credit Card’s Grace Period
As explained above, after you make a purchase with your credit card, the bank gives you a grace period. Typically between 20 and 30 days, during which you can pay off that purchase before interest begins to accrue.
Grace periods are powerful and important to understand. They give you the opportunity to use your credit card as a short, but interest-free, loan. As long as you pay every cent you borrowed from the bank last month, before the due date. You won’t pay interest on your credit card purchases.
The alternative is that you would have used your debit card to pay expenses. If you would have done that, it would have decreased the pot of money you hold at the bank earning interest. By paying your monthly expenses from your credit card you can earn interest on your cash in the bank. You won’t have to pay interest on the short-term loan. It is important to note however that this requires discipline and planning. This will be to your benefit in the long term.
Building a Credit Record
Another reason to make use of your credit card, or even a clothing account, is to use it to build up your credit record. The idea is that if the time comes for you to obtain long-term credit from a bank, you want the best possible interest rate that the bank can provide. There are a few factors that play into banks’ consideration of the quoted interest rate. An important factor is for you to show the bank that you will honour your debt obligation to them.
Unfortunately, the bank can’t take your word for it. The bank’s most trustworthy way to determine your discipline and commitment in servicing the debt owed to them is by considering your track record. Repaying your credit card debt is therefore important. This is not only to avoid paying high interest on it after the grace period has ended. Repaying your credit will ensure you get quoted good and reasonable interest rates when you need long-term financing.
A Few Tips in Being Responsible with your Credit Card
- Never spend more than you can afford, even though you have access to credit.
- If you do have outstanding debt, always repay short term debt off first, as it has very high interest rates. If you get paid a bonus, pay off debt before considering investing the funds.
- Credit cards can cost you upwards from about 12% per year – a fixed and certain cost. Investments providing such high returns are usually accommodated with high risks that are not certain.
- Don’t make use of your credit card if you know you will struggle repaying it – it can do more damage and harm than good.
Being responsible with debt is one of the most powerful ways to obtain a healthy financial situation. Aim to practise and understand this as soon as possible to not be caught in a trap that can easily spin out of control.
