HOW TO MAXIMIZE CREDIT AND DEBT

Credit and debt are the amount of money that you owe to other individuals and lenders like banks and finance institutions. Although debt has the benefit of helping you to have what you need now using others money, if not properly managed, debt can get out of hand and render an individual bankrupt. If you do not manage your debt well, you will be heading to rough financial future that will cause embarrassment, not only to you but your family as well.

 The current pandemic around the World coupled with debt has led to the bankruptcy of Hertz, one of the biggest car rental company in the United States. Hertz has accumulated debt worth $19 Billion which has exposed her to the large financial risk of paying interest that is associated with debt. It is apparent that Hertz had borrowed more than its capacity to carry debt, hence, had gone bankruptcy. Note that Hertz is one of the oldest companies in the US that is over 100 years old. So, any body can manage debt badly and go bankrupt no matter how rich or wealthy they are.

 Types of Credit

There different types of credit that you need to know about. I have explained these here for your information.

1.     Secure Debt: These are debts that the borrower has committed to surrender his valuable assets to the lender if he/she is unable to repay the debt as agreed. The asset that the borrower promised to surrender is called collateral. In fact, all loans that provide you with the money to buy assets like furniture, car, electronics, personal devices, home, etc are secure debt because these assets become the collateral to the loan. The interest charged by banks and lenders on secured loan is lower than the interest on unsecured debts, because the lender/bank can reposes the asset and sell to recover their money if you fail to make repayment. So, their risk is lesser.

2.     Unsecure Debt: These debts are not covered by any security to protect the bank/lender against repayment default by the borrower. The bank has nothing to hold unto in event the lender defaults on making repayment of both principal and interest on this loan. Because of their risky nature, banks charge very high interest to borrowers seeking to take these loans. Examples of these loans are pay day loans granted by consumer lending organizations like Renmoney, Zedvance, and credit cards loans.

 Good Debt Vs Bad Debt

Debt is undoubtedly a great way to build wealth if you know how to harness it well. So do not think that debt is a demon that is designed by banks to rob you of your peace of mind. I will let you know which debt is good, and which one is bad and should be avoided.

Good Debt: A good debt is the debt that increases your networth or has future value. A good debt gives you the opportunity to use others funds to build your own wealth and repay back the debt with ease. Examples of good debt are: taking out mortgage to build a home, borrowing to pay for your education, buying things that save you time and money, borrowing to invest in your business, etc. Good debt may put you in a hole initially but you will be fine in the long-run and better off financially.

 Bad Debts: These debts are the opposite of good debts. They do not increase your networth and does not offer you any future value. They are debts that are procured for consumption purposes. The easiest way to fall into the trap of bad debt is to borrow without a productive project in mind. For example, borrowing to buy 60 inches TV screen is a bad debt. Also taking auto loan is a bad debt except the vehicle in question is used for commercial purpose to produce some income. Payday loans are bad debt too. Also, your credit card loans are bad debt. One of the killers of financial health is credit card, because of their high interest rates.

 What is the COST of Credit?

Credit has a cost to the borrower. This cost is called interest rate. Interest is the fee that the lender/bank charge the borrower for using credit. So, when you want to borrow, first ask to know the amount of interest that will be charge on this credit by the bank. It is important to know this cost from the outset and possibly negotiate it before taking the loan. Do not ever take a loan with out knowing the interest rate that is charged on that loan by the lender. If the lender refused to disclose the interest rate to you, then do not accept the loan offer, because you would be ripped off if you did.

 As I have mentioned above, interest rate on secured debts are typically low because of the collateral that covers the loan, while interest rate on unsecured debts is usually very high to compensate the lender for taking risk to lend to you when you do not have collateral to cover the loan in case you default. Apart from this, other factors like inflation and central bank monetary policy rate as well as your credit score rate determine the interest rate that borrowers pay in a country. In Nigeria, the monetary policy rate is averaging 14%: this is the rate at which Central Bank of Nigeria lends to commercial bank. So, commercial banks add their own margin of like 4% on top of this to lend to customer at 18% interest rate.

For risky lenders who lend to high risk customer-like payday loans, some banks charged as high as 29% interest rate on those loans because they are highly risky to the bank. You must know about this cost of borrowing and select your loans wisely to avoid paying high cost when you are borrowing money.

 How To Know If you Are Borrowing Too Much

Debts can be mysterious as some time an individual may not know that he/she has been over borrowing until their debt level reaches the dangerous height. I want to provide you with a quick guide to determine if you have overborrowed or not.

 The Debt -to-Income (DTI) ratio is the measure that will tell you without any controversy if you have overborrowed and are highly geared or not. This is how to calculate your debt-to-Income ratio: add together all the monthly debts you have been paying and divide the resulting figure by your monthly income. Let me use this example to illustrate how to compute the DTI ratio. Supposing you are under obligation to repay these amounts to banks/lenders- N100,000 on car loan, 40,000 on personal loan and N70,000 on your mortgage loan. If your monthly income is N400,000, calculate your Debt-Income ratio.

Your debt income ratio is (N100,000+N40,000+N70,000)/N400,000 = N210,000/N400,000 *100% = 53%.

Wow, this is a high debt income ratio which shows that the person has overborrowed!

 The acceptable DTI ratio is 35%. Any number above 35% implies that you have overborrowed and it is risky for banks to lend to you because you may default. It has been established that people who have high DTI ratio are likely to default on their loans than those with low DTI ratio.

 Understanding Your Credit Score

You need to know your credit score because it has far reaching implication on your credit life and your financial health. Everyone needs a credit score, because with out credit score you will not be able to use debt to build your wealth. What then is credit score? This is the score assigned to users of credit by credit bureau agencies to describe the credit worthiness of those users.

 It is good to have a credit score and monitor your credit score because if you do not, you will be taking credit at a high cost each time you want to borrow because you do not have a credit score that will help the bank/lender in pricing your credit. The rule of the thumb is for the bank to assume that you will default and to charge you high interest rate to compensate for this risk.

 There are credit bureaus right now in Nigeria that issue credit score to all individuals who have bank account and Bank Verification number. One of them is CRC credit Bureau. Check their website and request for your credit score today-https://crccreditbureau.com/.

 Your credit score range from the score of 300 -599 for very bad to 800-850 for excellent as shown on credit score report.

Now, you may want to know the factors that credit bureau uses to rate your credit behaviour. Various factors such as Payment history, credit utilization, credit mix, new credit etc are used to score your credit behaviour. Among these factors, payment history which monitor how promptly you are paying your loans back account for 35% of your credit score; credit utilization accounts for 30% of your credit scores and it determines how much of credit lines you have taken out of the total credit line available to you in the economy- there is credit lines assigned to everyone that owns bank account and this is used to determine this. So you need to know all of these when you request for your credit score. Credit mix investigates how many different loans have you taken simultaneously and how have you been managing them? It accounts for 10% of your credit score.

 So, what steps do you need to take to improve your credit score? I will recommend that you follow these steps to improve your credit score:

·        Pay Back your Loan Repayment On Time: Do not delay repayment of your loans beyond the agreed date. Make sure you make your loan repayment earlier or exactly on that date you have agreed with the bank. Delaying repayment can reduce your credit score.

·        Pay Down Debt: If you have windfall income that come your way, use it to pay down debt and reduce your debt utilization ratio to improve your score.

·        Make Any Outstanding Payment: If you have any payments on your loan accounts that are past due, make sure you pay them and bring your account up to date.

·        Object Inaccurate Information on your Credit Score Report: If you request for your credit score report and found any information that is not clear to you, dispute it by contacting the credit bureau that has issued the report. This is why it is important to check your credit score report frequently.

·        Reduce the Number of New Credit Request you make: When you frequently ask for new credit, you will increase the number of hard enquiries on your credit file, and this will badly affect your credit score. Hard enquiries mean you have applied for a new loan and the lender has contacted the credit bureau to ask for your credit score. This enquiries is recorded in your credit file and is tracked by the system, so any new lender/bank you approach to borrow can check your file to know how many other lenders/banks you have gone to before coming to her.

 If you do not have credit score at all, then you need to start building one. And you can build a new credit score by approaching your bank and requesting for a credit card. Use this credit card to shop for your basic needs like grocery and make sure you pay back the credit you have taken via this credit card every month without failing. This is the easiest way to help you start building your credit score.

 Practical Strategies to Managing Your Debts

·        Refinance you Debts: Refinancing debt means using a cheaper debt to pay down an expensive debt. You might have borrowed some years back when interest rate was high, like say 23%, but the interest rate has fallen to 15% this year, which means any loan you take this year will be cheaper than the old debt. So, you can approach a new bank and ask them to refinance your old loan which is expensive. Refinancing this loan will help you 8% cost on interest rate. Is this not amazing? You would have demonstrated high financial skill and saved yourself a lot of money here.

·        Consolidate your Loans: If you have borrowed from different sources- mortgage loan, personal loan, auto loan; you can request a lender/bank to help you add up all these loans and put them together as a single loan and pay off all those numerous lenders you had borrowed from before. The lender might charge you a lower interest rate on the new consolidated loan granted and you will focus on paying your loan to one new lender/bank.

·        Always Pay your Debt On Time: Paying your debts late will badly affect your credit score. So, make sure you make your monthly repayment on time.

·        Monitor you Debt-to- Income Ratio: Make sure that you monitor your DTI ratio and keep it as low as possible because potential lenders will deny you credit if it is high.

·        Know your Credit Limit: This is the maximum amount of credit that you are qualified for. Do not borrow to exhaust your credit limit. It is advisable that you maintain credit balance under 30% of your credit limit.

·        Check if you Have Qualified for Lower Interest Rate: If your credit score has improved, your interest rate will drop; so check with your bank when borrowing and share your improved credit score with them to make a case for lower interest on your loans.

·        Take New Debt only when you need it: Take only good debt; that is debt that will increase your networth and bring future value to you. And even this, take such debt only if you absolutely need it.