Credit and debt

Credit and debt are not the same.  Credit is the ability to obtain goods or services before payment, based on the trust that payment will be made in the future. Credit cards, lines of credit and other sources of credit if not paid off, are really a form of “Debt”.

Many people use credit for immediate gratification, emergencies, convenience, or to purchase something. Credit should be used wisely as it has become very easy to access. I've heard jokes of people applying for credit cards in their pets name as a joke and then actually receiving the credit card for the pet.

Credit can be very costly

Did you know that when you purchase an item on sale or a discounted item on your line of credit or credit card and don’t pay it off at the end of the month, it can cost more than you would have paid at full price because of the added interest. It is wise to think before purchasing.  One example is to delay a purchase and leave the store so you can go home and think about whether or not you really need the item. Ask yourself is you would pay double the price for the item?

Another strategy is to think about how many hours it takes for you to earn enough money to buy that item. For example, let's say something is on sale for $1000.  If you think about it, you have to earn more than $1000 to spend $1000 because you have to pay tax.  $1000 after tax may be the equivalent of $1500 before tax. If you buy that item on a 19% credit card and make $100 per month payments dollars, the interest cost is almost another $100 on the price. Change that interest to pretax dollars and you are paying over $140 just for the interest. Now the real cost is over $1700 for a $1000 “sale” item. If you don’t pay this off in the first year it will cost you even more! In this case credit has turned into debt.

Credit Scores and Credit Ratings

Do you know how to read or understand your credit score and credit rating? You can obtain your Credit Score and Credit Rating from either Equifax Canada or TransUnion Canada. This information is posted on the Canadian Government website.

Your credit score is a rating somewhere between 300 to 900. The higher your credit score, the lower the risk is to the lender. The higher your score is the easier it is to negotiate a lower interest rate on any credit you receive. The credit score is based on these 5 factors:

  1. Payment history
  2. Debt
  3. Age of your accounts
  4. New accounts and number of inquiries into your credit
  5. Types of credit

Many people think making an inquiry into their own credit report hurts their score.  This is a false assumption. when a creditor checks your report it can affect your score. Due to the prevalence of identity theft it is wise to check your credit report annually.

Credit Rating is a ranking of each credit (debt you currently have or had in recent years)
Each entry has a letter and a number, the letter is the type of debt:

  • Instalment – “I” – means there is an end date to the credit with fixed payments.
  • Open credit – “O” – a line of credit, the credit stays open for you to use at any time
  • Revolving – “R” – credit cards, credit is always available up to your limit, you must make regular payments

According to the Canadian government the most common credit ratings are “R” which means revolving credit. Credit cards are an example of revolving credit.

The numbers that are with each entry go from 0 up to 9 and mean how timely you make your payments. 0 means unused or new, 1 is pays within 30 days or due date, continues on up to 9 which means a bad debt.

A recent article on Alberta statistics states that :

  • 34% of Alberta Baby Boomers do NOT have RRSP’s
  • 51% of Alberta Baby Boomers do NOT have a company pension plan
  • Average debt for 65 and over in Canada is $47,549 (as of 2012)
  • and age 45 to 65 is $92,819.

Perhaps the cause of Baby Boomers not having retirement savings is that many are going into the golden years still burdened with debt because of the ease with which we can obtain credit.

Written by Cathy Leahy

Cathy Leahy is the author of Keystone Diaries – Money Keys a financial literacy book for children. She has been working in the Financial Services Industry since April 2000 and volunteers her time with Junior Achievement and The Rotary Club working with high school students.

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