University of Missouri Extension

GH3341, Reviewed June 2009

Credit in the Family Budget

Joyce Cavanagh
Consumer and Family Economics Specialist
Laura Reynolds,
Graduate Assistant
Human Environmental Sciences Extension

Consumers use credit widely throughout the United States. Many people don't even give much thought as to whether they should use it. The buy-now, pay-later philosophy has become a way of life, and, for many people, has resulted in serious financial difficulties.

Pluses and minuses of credit

When carefully used, credit can have some financial benefits. A look at the advantages and disadvantages of using credit can help determine when the use of credit is appropriate.

Advantages

Disadvantages

Should you buy on credit?

Whether or not to use credit is a decision that requires careful examination. Before buying, look at your total financial picture including current income and expenses as well as future goals. Look at the effect of the monthly payments on your current budget.

Evaluate the impact of the loss of future income on your goals and the opportunity for using the money for other things. Before buying anything on credit, ask yourself the following questions.

General guidelines for using credit suggest borrowing only to finance an investment such as a home or education. However, consumers often use credit to buy expensive, fairly durable items such as a car or home furnishings.

Food, clothing, transportation, entertainment and other daily family living expenses should come out of current income. If bills can be paid without incurring finance charges, short-term credit for daily living expenses might be acceptable because of convenience. However, ask the retailer for a cash discount. If one is available, you will save money by paying cash.

Situations where credit might be useful

How much credit can you manage?

The use of consumer credit is not always a matter of affordability, but rather a matter of priorities. You must decide whether the immediate gratification of buying something before you have the money is worth the extra cost of credit. Buying on credit now will delay reaching other goals in the future.

The amount of debt a family can manage depends upon the amount and reliability of income and total financial obligations. General rules are of limited value. Some families cannot afford any monthly payments while others are able to make payments on several accounts.

Use the 20/10 Rule when trying to decide how much debt your family can handle. This rule advises not to borrow more than 20 percent of your annual after tax income, and your monthly payments should never exceed 10 percent of your monthly after tax income.

The general rule of limiting your consumer debt payment to no more than 20 percent of your take-home pay is frequently interpreted as meaning that it is all right to keep your debt payment level at about 20 percent of your take-home pay. Suddenly the maximum advisable debt level has become the norm for safe debt level.

While it is true that you may be able to make the installment payments without experiencing great sacrifice, this practice is not sound financial planning. A better practice is to use the money saved by not using credit and apply it to financing future goals. This will help shorten the time needed to accumulate the money to realize your goals.

However, if it is necessary or desirable to use credit, shop around for the best buy. Look for the lowest annual percentage rate and most favorable contract terms. Make as large a down payment as possible and make the installment payments for the greatest amount that can be comfortably accommodated in your budget. These strategies all work to lower the cost of using credit.

If you are already using credit, evaluate your present situation. How much are you paying in finance charges each month? Would that amount help you realize another goal sooner? Is the instant gratification received from buying on credit worth the extra cost? Are your debts creating problems for you? Warning signs that you have reached or are near your upper debt level include:

GH3341 Credit in the Family Budget | University of Missouri Extension

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