OBTAINING AND USING CREDIT

Responsible use of credit helps keep you from experiencing finanacial problems.
Responsible use of credit helps keep you from experiencing finanacial problems.

Credit is a way of getting goods and services now and paying later. But it's critical to go into more detail about credit to avoid falling into a cycle of debt.

Obtaining credit means receiving a loan. The borrower must repay the funds, with or without interest, before a fixed date or be obliged to pay additional interest.  Different companies have different repayment methods.  Three common forms of credit are credit cards, instalment plans and mortgage loans.

Credit cards

A credit card can be a very useful financial tool that makes everyday life easier. One of its advantages is that it allows the holder to use a good or service immediately while distributing payments over time. It also enables people to establish a good credit rating so they can borrow more significant amounts in the future. It can act as an emergency source of money, and having a preset spending limit may keep people from spending more money than they can afford.

However, it's important to use credit cards wisely. There is always the danger of theft, fraud and administrative error. But the biggest danger comes from not paying off credit cards right away. Unpaid balances can grow very fast once high credit card interest rates are factored in. Rates of 19% and higher are not uncommon.
The best way to use credit cards is to pay them off every month. Otherwise, the interest charges add up quickly. Take a look at the following example to see how this can increase the actual cost of credit purchases.

Interest

The interest on borrowed money is the price people pay to have immediate access to money they don't have. For example, people rarely have enough cash to buy their first house. That is why they go to a financial institution to borrow the required funds. In exchange, the institution charges a type of fee, called interest, on the borrowed money. It is one of the ways in which banks and financial institutions make money. Borrowers get the money to buy their homes, and every month they reimburse a part of the borrowed sum plus interest.

Calculating interest on a credit card bill:

  Amount due: $5,000 
  Elapsed time: 1 month 
  $5,000 × 19% = $950 
  $950 / 12 months = $79.16 
  $79.16 × 1 month =  $79.16 


The amount that is owed went from $5,000 to $5,079.16 because of the interest charged.

How much interest do we pay?

An interest rate is the amount paid for a loan, expressed as a percentage of the borrowed sum. It is determined when the loan is made. It can remain the same (fixed rate) until the loan is paid, or it can be a floating rate, which moves up and down based on the interest rate set by the Bank of Canada. Interest rates are usually fixed annually, but compounded monthly (compound interest).

Excerpts from the Office of the Superintendent of Bankruptcy Canada’s “The Financial Guide”

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