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(continued
from previous page) Credit
wars: revolving vs. installment
By Teri
Cettina • Bankrate.com
The big trap
It's precisely this combination of easy access and low required
payments that get so many people get into credit-card trouble, says
Gerri Detweiler, author of "The
Ultimate Credit Handbook". "Those low minimum payments
are a big trap," she says. "If you only pay the minimum,
you could be paying your credit card company until you die -- literally!"
Why? Because you're paying mostly interest -- not paying down the
principal -- on the money you've borrowed.
"It can take a lot of self-discipline to make
you pay more than just the required minimum that appears on your
revolving credit statement," Detweiller says.
In addition, most of us are inundated by credit card
and credit line offers -- both through the mail and at retail stores.
Also, very few retailers offer installment loans for purchases,
notes Detweiler. Instead, most of them offer their own store-name
credit cards, often with enticing rates and payment waivers. However,
once those introductory deals end, in-store credit card rates can
be much higher than your plain-vanilla MasterCard or Visa.
Matt Russell, branch manager of Wells Fargo Bank in
Lake Oswego, Ore., says consumers should carefully weigh the choice
of loans vs. revolving credit when they buy big-ticket items. He
says many people don't realize they can get personal loans and lines
of credit from their bank or credit union to buy computers, furniture
or just about anything imaginable. The advantage: Loans and credit
lines often carry much lower interest rates than credit cards, depending
on the applicant's credit history.
"Before I suggest that a customer open or use
a credit card account, I always look at their financial situation.
If they own a house, I might first suggest they consider a home
equity installment loan or a home equity line of credit. The rates
are better than on credit cards, and the customer might be eligible
for a tax deduction," he says.
"If home equity isn't the right choice, I'd look
at -- in order of lowest interest rates -- a secured installment
loan, then a secured line of credit, next an unsecured loan and
finally an unsecured personal line of credit," says Russell.
"All of these choices might be better than using a credit card."
The one caveat on both home equity and personal lines
of credit, Russell says, is that you have to be diligent about paying
them off. Otherwise, you can rack up huge amounts of interest, just
as you can with credit cards.
"If your monthly credit line payment is automatically
debited out of your checking or savings account -- which most financial
institutions now require -- it will only be for the minimum required
amount," he explains. "You'll have to manually arrange
to pay more than just the minimum."
Here are some additional considerations when
choosing between installment loans and revolving credit:
Match credit term to the life of the item.
A. Todd Black, a fee-only financial planner in
Cumming, Ga., says the more-expensive and long-lived the item will
be, the more sense it makes to use an installment loan. "Buying
a house with a 30-year mortgage (an installment loan) makes sense
because the house will still have value when the loan is paid off,"
says Black. "Car loans are also best paid for with installment
loans, usually not more than 60 months."
If you're buying something less expensive and
more temporary, such as back-to-school clothes for your child, revolving
credit (such as a credit card) can be fine. However, credit expert
Detweiller suggests you pay off your card each month or use a debt
repayment calculator to ensure that you're not paying on your
card until the cows come home.
Understand the true cost of your debt.
If you take out an installment loan, be
sure you understand the fine print. Will you pay annual fees or
prepayment penalties? What is your interest rate, and is it variable
or fixed? Calculate
the interest you'll pay over the life of the loan.
If you're paying with revolving credit, use
Bankrate's
calculator to find out how much you're actually paying in interest
and principal.
An example: Consider the purchase of a suite
of furniture for $3,500. For the sake of comparison, assume that
both a loan and a credit card carry the same interest rate (although
that would be extremely unlikely). Here's what you'd pay:
|
| Initial Balance |
$3,500
|
$3,500
|
| Interest Rate |
10%
|
10%
|
| Years to Repay |
5
|
*14.8
|
| Interest Cost |
$961.88
|
$1,638.54
|
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*Assumes that you pay only the required minimum
payment (calculated as 2.5% of your balance) each month.
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Approach special offers cautiously.
"Many people are enticed by retail stores that offer
10 percent off all purchases that day if you open a store credit
card. If you pay off the balance on that credit card immediately,
that's a good deal," says Russell. "However, if you don't
pay off your card, a 10-percent discount is nothing compared to
the 18 percent or whatever in interest you'll eventually pay."
Black recently took advantage of a special offer of
12 months with no required payment and no accrued interest when
he used a Home Depot credit card. He bought a $500 pressure washer
and used the special financing carefully. "I made sure I paid
off the item in less than 12 months -- in fact, $50 a month for
10 months. Otherwise, in month 13, I would have been subject to
a much higher interest rate."
Leverage your banking relationship.
If you already have accounts or loans at a bank or credit union,
check out your credit options. Many financial institutions will
waive annual loan or credit line fees or reduce your interest rate
as a "thank you" for broadening your relationship with
them.
Do your homework. Whenever
possible, plan your purchases in advance. "Impulse shoppers
always end up in the most debt," says Detweiller. Also, check
out your financial options before you set foot in your favorite
furniture or computer store. Know the rates and terms for lines
of credits and loans at your bank or credit union. You can even
get pre-approved for a bank or credit union loan before you go shopping.
Finally, check the rate on the credit cards you already have. That
way, you'll know whether in-store financing offers are a
good deal.
Teri Cettina is a freelance writer
based in Oregon.
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