Learning Objectives
- Develop strategies to avoid being burdened with debt.
- Explain how to manage monthly income and expenses.
- Define personal finances and financial planning.
- Explain the financial planning life cycle.
- Discuss the advantages of a college education in meeting short- and long-term financial goals.
- Explain compound interest and the time value of money.
- Discuss the value of getting an early start on your plans for saving.
The World of Personal Credit
Do you sometimes wonder where your money goes? Would you like to buy a new car or even a home someday and you’re not sure where you’ll get the money? If these questions seem familiar to you, you could benefit from help in managing your personal finances, which this chapter will seek to provide.
Let’s say that you’re 28 and single. You have a good education and a good job—you’re pulling down $60,000 working with a local accounting firm. You have $6,000 in a retirement savings account, and you carry three credit cards. You plan to buy a condo in two or three years, and you want to take your dream trip to the world’s hottest surfing spots within five years. Your only big worry is the fact that you’re $70,000 in debt, due to student loans, your car loan, and credit card debt. You can afford the necessities of life and then some, but you’ve occasionally wondered if you’re ever going to have enough income to put something toward that debt.[1]
Now let’s suppose that while browsing through a magazine in the doctor’s office, you run across a short personal-finances self-help quiz. There are six questions:
You took the quiz and answered with a B or C to a few questions, and are thereby informed that you’re probably jeopardizing your entire financial future.
Personal-finances experts tend to utilize the types of questions on the quiz: if you answered B or C to any of the first three questions, you have a problem with splurging; if any questions from four through six got a B or C, your monthly bills are too high for your income.
Building a Good Credit Rating
So, you have a financial problem. According to the quick test you took, you splurge and your bills are too high for your income. If you get in over your head and can’t make your loan or rent payments on time, you risk hurting your credit rating—your ability to borrow in the future.
How do potential lenders decide whether you’re a good or bad credit risk? If you’re a poor credit risk, how does this affect your ability to borrow, or the rate of interest you have to pay? Whenever you use credit, those from whom you borrow (retailers, credit card companies, banks) provide information on your debt and payment habits to three national credit bureaus: Equifax, Experian, and TransUnion. The credit bureaus use the information to compile a numerical credit score, called a FICO score; it ranges from 300–850, with the majority of people falling in the 600–700 range. In compiling the score, the credit bureaus consider five criteria: payment his