5 Questions with Ruth: Credit

Credit is one of the most exciting aspects of money - it means that you can have a product or service now without spending any of your money at that moment. Credit can also cause stress. It’s clouded by dodgy loan sharks, bad habits and low levels of understanding.

With so much conflicting information around credit out there, who better than our good friend Ruth, The Happy Saver, to help us demystify some of the thornier questions. Ruth helps hundreds of people along their financial journey and you can find more great advice on her blog and podcast.

1. Everyone has one… so a credit card isn’t that bad right?
2. If I don’t have a credit card or savings, then what do I do if I get hit by a surprise bill?
3. What’s the best way to pay off my various debts?
4. Why should I pay my bills on time?
5. Is my credit score important? Why or why not?

1. Everyone has one… so a credit card isn’t that bad right?

First off, no they don’t!

A credit card simply lets you use someone else’s money for a period of time before you have to pay it back. And if you don’t pay it back, then you will be charged interest and that interest rate is generally pretty high. Plus you will also pay an annual fee to use this card.

Many people justify using a credit card for two reasons:

• They earn reward points that more than cover the annual fee, which means they come out ahead.
• They will always pay the balance of the card off in full and never pay interest.

There are many users who manage this and for them, having a credit card isn’t that ‘bad’ at all.

Trouble is that there are many more users who can’t manage this and for them, a credit card can be a slippery slope into consumer debt where they are constantly spending money they don’t have and pre-committing any future income to paying off this debt, plus interest. Yet they keep shopping and surrounding themselves with items they don’t actually own.

A credit card feels like a rite of passage for many people. They even feel that they ‘need’ one in order to shop online, book hotels or get a rental car. But the evidence is pretty clear that people who use a credit card instead of cash spend more money because they do not feel the immediate pain of seeing their bank balance drop when they make a purchase. The pain is deferred until the statement comes out the following month!

So, I suppose what I’m saying is that a credit card is not ‘bad’ as such, but the way we use it can be. Having had one myself I found that the benefits I thought I was getting were just not there once I worked the math out. Therefore the easy way around it is to just use a debit card, which uses your own money from your own bank account - no fees and no interest to pay and you can be certain that you will spend more carefully!

2. If I don’t have a credit card or savings, then what do I do if I get hit by a surprise bill?

You rewind your life about one year and you start setting money aside for the ‘surprise bill’. That way when the surprise is upon you, it’s not that surprising at all and you just reach over into your ‘surprise bill bank account’ and pay it.

Jokes aside here is the thing, there will always be a surprise expense - unexpected things happen to everyone and as soon as you comprehend that you can plan for it. Those who succeed with money plan ahead by creating an emergency fund, a sum of cash set aside in a separate bank account ready to fight any financial fires. If you have other debt you are paying off this may just be an amount of $1,000 to $2,000, it’s an amount that covers anything unexpected and stops you reaching for a credit card to pay it. As you become debt-free, you can build this up to three to six months of living expenses which will solve many, if not all, financial emergencies that will inevitably come your way.

If you do find yourself in the middle of a financial pickle with a bill needing to be paid, there are a couple of practical steps you can take. Swallow your pride and speak with the company you owe money to and explain your situation, that the invoice will be paid but that you just need a little time. Keep communicating with them. Next, stop all unnecessary spending - like takeaway coffee, extras at the supermarket, a weekend away - and put that money towards your bill.

Be resourceful. Sell unwanted items and work more hours to create income. In short, make your life uncomfortable in the short term to fix up this surprise bill, pay it in full and then vow to structure your money in such a way that it’s unlikely to happen again.

3. What’s the best way to pay off my various debts?

There are two schools of thought on this:

• The Avalanche method where you pay off the debt with the highest interest rate first and then work your way down through your debts paying off the one with the lowest interest rate last.

• The Snowball method where you pay off the smallest dollar value debt you have (regardless of the interest rate) and then work your way upwards through your bigger debts until you are debt-free.

Both have merit. The Snowball method takes the psychology of debt repayment into account because when you’re focussing on clearing debt, math is only one aspect of it. Your behaviour and emotions play a huge part in sticking to a plan.

Often an item with a higher interest rate is a large value item, such as a car or a home and aggressively paying off that debt until it’s gone can take a very long time. Along the way, it’s very easy to lose motivation. With the snowball method, the first debt may only be $100. But if you can focus on aggressively and quickly paying that off, you will feel a huge sense of achievement, which in turn gives you the motivation to pay off the second-smallest debt, then the third. By the time you come to that car payment or your mortgage, you have had many small wins along the way and the goal feels much more achievable.

Whichever path you choose, your first task is to list down all your debts from smallest to biggest. Next, make sure you set up regular payments for all of them and then choose one - either the smallest dollar amount or the one with the highest interest rate - and make additional payments to that until it’s gone. You then redeploy that payment to the next debt and so on until you are debt-free.

4. Why should I pay my bills on time?

Because you agree to use a service, such as signing up to a phone account, and part of that agreement was to pay on time. If you fail to do so, the only one who will be suffering is you, when they charge you late fees or disconnect your phone.

It’s stressful knowing that you owe money. If you are struggling to pay your bills on time, think about setting up a bank account for a specific bill that you transfer money into as soon as you get paid, that way you will always have the money available to pay in full. Another option is to pay weekly regular amounts directly to the provider, that way you won’t be tempted to spend the money and your bill will always be paid in full by the due date.

5. Is my credit score important? Why or why not?

A credit score simply shows your ability to handle debt. My personal view is that if I avoid taking on any debt, especially consumer debt, it negates my need to have a credit score.

Ruth blogs at thehappysaver.com all about how she and her family handle money. What’s the secret? Spend less than you earn, invest the difference, avoid debt and budget each dollar that flows through your hands. She firmly believes that if you can just get the basics right, life becomes easier from there on in.