Responsible Borrowing

Everybody needs a little extra money now and then to pay bills or cover unexpected expenses. But without debt management experience or proper debt planning, a family can soon find themselves in a spiral of debt. Whether it’s making minimum payments on your credit cards or taking your valuables to a pawnshop, being stuck in the debt cycle can cause damage for years to come.

One rule of thumb is that debt should not exceed 20 percent of your take home pay. Another way to handle debt is to set a threshold—for example, no more than 40 percent total debt ratio (all debts divided by take home pay). The key is to know how much debt is reasonable and set a plan to give yourself a better chance of lowering it.

In order to keep yourself out of a bad credit situation, there are several key things you should know about borrowing money.

The true cost of borrowing

Using credit or debt to pay for purchases is a fact of life in today’s economy, but overdoing it may lead to bad credit. Military loans can be a smart solution, but it’s worthwhile for you to learn how to accurately evaluate lending options. Why? Because all bad credit military loan options are not the same. In the haste of the moment, when you’re desperate for cash, you may not be paying enough attention to what a loan is really costing you.

One way to compare different types of borrowing is comparing interest rates or annual percentage rates (APR). The problem with doing so is that the term, or length, of the loan is just as important in figuring out the actual cost.

For example, a 90-day $300 loan at 34.95% is often seen as a bad decision, while borrowing $300 at a cost of $17.34 is a much better deal. The problem is that these numbers represent the same loan.

You cannot just focus on rates and fees alone when determining the real cost to you, especially when borrowing over a short period. The term of the loan must also be considered.

The truth about credit cards

Comparing the true cost of a credit card can be conflicting and confusing, and much has been written to better educate consumers about the true nature of bad credit card debt.

Beyond interest rates, fees, grace periods, and balance calculations, a recent concern has been minimum payment amounts and the length of time for full repayment. Elected leaders, non-profit organizations and businesses have recently begun education efforts to help consumers better understand costs associated with long-term credit card debt.

To highlight some truth about credit cards, take three examples:

• If you had $1,000 of credit card debt at 12 percent interest, and only made the minimum payment of four percent of the balance, it would take you 74 payments—more than six years—to pay off. During that time, you will have paid nearly $300 in interest.
But if you had a fixed rate loan for the same amount—even at 30 percent interest for 12 months—you would have only paid $169.85 in interest.
• If you had $2,500 of credit card debt at 17 percent APR, and only made the minimum payment, it would take you 119 months (nearly 10 years) and cost you nearly $1,300 in interest.
• And if you owed $5,000 at 17 percent interest, you would make payments totaling $7,665 over 145 months (12 years) if you only made the minimum monthly payment.

You can find out how many years you will pay on your credit card debt by using our online calculators.

The truth about payday lending

Payday lending is full of dangers. According to the Center for Responsible Lending (CRL), 91 percent of all payday loans are made to borrowers with five or more payday loans per year—on average, they receive 8 to 13 payday loans from a single payday lender—while only one percent of all payday loans are made to one-time emergency borrowers. And most payday borrowers go to more than one lender, dramatically increasing the number. A 2004 CRL study noted that one in five (20 percent) military families used a payday loan service.

A typical payday loan—$300 to $500—is due in full on the following payday. A military family that borrows $300, yet is not able to pay it off at the end of two weeks, will find themselves paying another $45 to $60 each time they roll it over. According to CRL, the average $325 payday loan results in total payback of $800.

The fact is, when one looks at the true costs, payday loans are simply not a financially sound way to borrow money.

One of the main issues with this type of lending is automatic "rolling over" or "flipping" because of an inability to repay. This can start you and your family on a financially dangerous cycle of debt.

Most cash-strapped borrowers who get payday loans are not able to repay the whole loan within two weeks, and end up rolling over their loan and paying renewal fees multiple times. Trapped on this "debt treadmill," military families typically pay much more in fees than the amount they originally borrowed.

The key question that every military family in a financial emergency should ask: "If I don’t have the $500 today, what are the chances I’ll have the money in two weeks?" If the answer is "slim to none," the rollover cycle is bound to begin.

The problem is that many people feel payday loans are their only option when the have bad credit. Military loans, unsecured personal loans, and other financial options, can help.

Bad Credit? Military Loans?

Have bad credit? Military loans are still a possibility. It is a myth that you must have good credit to get a loan, though the better credit you have, the lower interest rate you will end up having to pay. For active duty and career retired military personnel with less than perfect or bad credit, military loans provide access to funds when they are needed and provide ways to build a more robust credit history. Instead of relying on high interest credit cards, predatory lenders, or payday loans, if you have bad credit, military loans are a responsible debt option.

Know the disclosures

• There are several laws designed to help you better understand the fees and other costs associated with obtaining credit.
• The Truth in Lending Act and Regulation Z (TILA)—Passed by Congress in 1968, TILA provides a uniform manner of calculating and presenting the terms of consumer loans. It mandates specific disclosures that enable you to compare costs in order to help you make informed credit choices.
• The Consumer Credit Act of 1974—This law developed APR calculations in order to provide a standardized formula for determining loan costs. Today, APR disclosures must comply with the Truth in Lending Act and Regulation Z, which means the total cost of a loan must reflect interest charges, loan fees and points.
• The Fair Credit and Charge Card Disclosure Act—This was passed in 1988 to further ensure uniform disclosure of rates and costs.

The last law required all issuers of credit (including banks, credit card companies, military loan providers, and other loan companies) to provide consumers with disclosures that must be provided with applications and pre-approved solicitations:

While these disclosures are helpful, they still may not reflect the true cost of credit. Consider a $100 loan for 14 days, with a $25 fee. The disclosed annual percentage rate is 651 percent. This may seem like an excessively high interest rate, but the reality is simply the $25 cost. A bank might charge you the same $25 if you “bounced” a check. This bank fee does not require a TILA disclosure, but if you calculated the APR, it would exceed 3,000 percent.

Make sure you read all the disclosures and know what fees you may be charged in the future so you are not hit with any surprise costs.

What to ask when borrowing money

When you have to borrow money, you should ask all of the right questions, insist on full disclosure, and know the true costs and terms to ensure that you are making an informed decision. Without complete information, what looks like a good deal may in fact be a bad one.

These questions can help ensure that you are fully informed and are making the best choice for you and your family. If military families structure their debt and the repayment plans in a disciplined manner, they can limit borrowing costs and avoid a debt cycle.