How to Live Debt Free - 12 Steps to Total Financial Freedom

-Kurt Vonnegut Jr

Why are we obsessed with using credit in this country?

After all, isn't this country based on the principles of being an ownership society? But if you have debt, whether it is credit card debt, a car loan or mortgage, you really don't own anything, the banks do. You are merely paying for the privilege of using it.

How's that for a harsh dose of reality!

Don't misunderstand me; I believe credit and credit cards are a very useful financial tool, when used properly. That's the key. Knowing how to use it properly. Having the knowledge and education necessary to not become another heavy debt statistic.

In this, step 4, you will learn what credit is and how to use it wisely.

Let's look at the common definition for what credit is.

I have stated before that credit gives consumers the opportunity to over pay for goods and services. Credit is the granting of a loan and the creation of debt. Credit cards allow a constant line of credit to spend and be paid off regularly. You usually do not have to pay any interest as long as you pay the full amount by each due date. Before you spend using a credit card, you should be sure you can repay the amount on time, as some credit cards can have very high interest rate.

Debt to Income Ratio

Debt to income ratio looks at how much you owe compared with how much you earn. It usually gives a clear picture of your financial well being. The lower your debt ratio, the more you have left over to save or spend on other things.

Your debt ratio is the percent of your monthly take-home pay that goes to paying debts and monthly obligations. You calculate it like this: Take the amount needed to repay debts each month, including rent r mortgage, and divide this by your take-home pay (your net pay after deduction of tax).

Many experts recommend that no more than 15-20% of your monthly household take home pay (excluding rent or mortgage) should be used to pay debts and make loan payments.

Credit to Debt Ratio

Understanding the Credit to Debt Ratio can help you improve your credit score. You need to know what happens when closing credit card accounts and how that affects your FICO score as an important part of getting out of debt and improving your credit rating.

One of the biggest fallacies I've seen perpetrated on the web, at the bank, etc., is that you should close credit card accounts that you are no longer using to improve your FICO score.

When you close the account, your "history" is gone for that credit card ... yes, it will still show up on your Credit Report; but the "good history" will no longer be included in the calculation of your FICO score.

The formula for calculating your credit to debt ratio is amount of debt used divided by available credit. If you can keep your debt load (the debt part of the debt/credit ratio) under the 50% mark, the better off you will be in the long run.

Finally, when using credit cards responsibly you need to select the right card. Shop around because they all carry different fees and rates. Before applying for a credit card ask yourself these questions:

Why do you want/need a credit card?

Maybe you need one credit card with a special interest rate to transfer balances from multiple accounts or perhaps you need a card specifically for business purposes. Being able to earn rewards, cash back or airline miles for your everyday purchases can also be a reason to get a credit card.

How much do you need to charge at one time?

If the credit card is for business purposes, maybe you need a card with very high or no spending limits. On the other hand, if this is your first card and you are trying to build credit or just want the card for emergencies, then a more modest spending limit may be the better route to go.

How do I want to pay back the charges?

Decide if you want to pay off the entire balance each month or just a portion over each month. Some cards offer advantages for both paying structures.

Do special offers interest me?

Many credit cards offer special rebates, support for a specific organization or other member benefits for using their credit cards. Decide if this is important to you when choosing your card.

Managing Credit

Now that you know what type of credit card you want, it is time to manage your credit.

A credit card is a responsibility, not a right. Understanding why you want a credit card, knowing how the credit card process works and picking a credit card that works best for you will help you avoid debt management pitfalls. Use your credit card to extend your buying power while keeping in mind that a credit card is not free money.

To maintain a good credit rating, you will need to pay your credit card statements in a timely manner, according to your agreed-upon terms of use. Never only pay the monthly minimum and if you could pay off your balance in full each month, do so. You will be far better off. Be responsible with your credit and enjoy the benefits credit card possession can bring. If you have questions or concerns about what is the right card for your specific credit or financial need, talk to a professional financial advisor. Take the extra step and be sure you understand everything you need to know before applying for a credit card.