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Cost of Consumer Credit
Today, credit is used to buy almost anything. American families travel, eat and attend college on credit. They charge everything from flowers to gasoline. There are advantages as well as disadvantages that must be considered if credit is to contribute to, rather than detract from, your familys financial health.
A major advantage of credit is having the use and enjoyment of goods and services while paying for them. For major purchases, such as an automobile, a house, a childs education, or a major home improvement, credit may be the only way a family can handle the large financial obligation. Another advantage of credit is the convenience, since it reduces your need to carry large amounts of cash and permits paying several expenses at one time.
Disadvantages must also be considered. When using credit, you pay for the privilege of using someone elses money - a finance charge. So, buying on credit typically costs more than paying cash. Credit ties up future income, providing less freedom in spending future income. A major disadvantage of credit is that it tempts the consumer to overspend, to buy goods and services on impulse, or to lose track of total debt.
Because you are, in effect, borrowing or renting someone elses money, credit almost always involves a cost. Knowing two basic terms will enable you to compare the cost of credit. The finance charge is the total dollar amount you pay to use credit. It includes interest, and sometimes a service charge, fee for credit report, or other costs of using credit instead of cash.
The annual percentage rate (APR) is the percentage or relative cost of credit on a yearly basis. It is the ratio between the finance charge and the amount of credit actually used during the year.
Credit is a promise. You are promising the creditor to repay the amount borrowed, plus the finance charge and other permitted charges for which you agree to pay. For this privilege, you are making a legally binding commitment. It is extremely important that you know your rights and responsibilities - as well as those of the creditor.
Read carefully before signing a credit agreement. If you dont understand something, ask the creditor. If you still dont understand, or are not satisfied with the explanation, consider contacting an attorney. Make sure no blank spaces are left on the contract (which could be filled in later). Also, look for such information as the amount borrowed; the finance charge and annual percentage rate; any other charges not included in the finance charge; the number amount and due dates of payments; date finance charges begin; a description of any collateral pledged to the creditor; and what happens if you fail to make payments.
Millions of Americans use credit. When kept under control, it can be a tool to help individuals and families live more comfortable and satisfying lives. When abused or used excessively, it can bury families deeply in debt and result in tremendous financial and emotional stress.
As consumers, you have the responsibility to understand the advantages and disadvantages of credit, how much it costs, the types and sources of credit, and the credit protections afforded by law. Then you need to use this information when deciding whether or not to use credit.
Resource; K-State Research and Extension, "Change for Your Dollars: Part 3: Your Use of Consumer Credit".
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