We have discussed some of the basic functions of the credit card. “But Colby what do these rates and acronyms mean? And this contract needs a magnifying glass to read the fine print.” Obviously we still have some material to cover concerning credit cards. The material discussed may seem eclectic but that is because when it comes to credit cards there are a bunch of seemingly unrelated pieces that add together in that tiny piece of plastic.
Continue reading All About Credit Cards (Part 2)
Ah the credit card. When you think about it ideas of platinum and gold cards and the high life may come to mind. This is part of the story. The other part of the story is that using a credit card irresponsibly can burden a person with an enormous amount of debt and keep him up late at night. So what is a credit card and how does it function?
Continue reading All About Credit Cards (Part 1)
You have probably seen commercials about “improving your credit score” or companies that will “give you your credit score” now you may be thinking “What the hell is a credit score?” Put simply a credit score is a three digit number that indicates how reliable you are as a borrower. Why does that matter? When you apply for a loan at a bank the bank has to evaluate whether to loan you the money and what interest rate to charge you. If only there were a way for a bank to see how you have paid other loans and whether you default (don’t pay) on a lot of loans. Surprise! There is a way and it is called credit-scoring systems. So before we delve deeper remember that the better your credit history and thus your credit score, the easier it is to obtain a loan and the lower the interest rate you will be charged. Also remember that debit card payments and cash payments are not relevant here. Only credit financing (credit cards, loans, etc.) affects your credit score and credit report.
Continue reading Credit Scores, Credit Reports, And Why They Matter
So we have discussed a bit about returns and rates, but there is some terminology that needs to be addressed and will make you a bit better off for knowing it. At the end of the day interest rates are pretty powerful things that shape the entire financial system, so let’s learn a little more about them. (Warning: simple math ahead so non-math types bear with me).
Continue reading All About Interest Rates
I know what you are thinking. Colby…why are you starting these personal finance lessons with such a boring topic? This is a valid point but my rebuttal is simple: without this lesson you will not understand the rationale behind 99% of all financial decisions so I ask you to bear with me and promise we will get to more interesting things.
- A dollar today is worth more than a dollar tomorrow
- A future amount of money has to be discounted to the present
- A present amount of money can be grown in the future
Why is time equal to money? I will answer this question with another wonderful cliché. Time is money because “a dollar today is worth more than a dollar tomorrow.” Why is this?
Imagine I being the benevolent man I am make you an offer. I will either A. Give you $100 today or B. Give you $100 next week. Which should you choose? If you feel inclined to say “the $100 today” you are absolutely correct.
That answer begs the question: why is that the better deal? It is a better deal because that cash in hand has earning capacity. Put differently with that cash in hand you could lend it out charging a certain percentage to the borrower (an interest rate) and grow the money you previously had to a larger sum. YAY more money!
This concept may seem simple but it serves as a foundation for nearly every financial decision made.
Present Value and Future Value
So let’s introduce some really fancy words that are actually quite simple to understand. If you choose to take the $100 today that money represents your present value. As the word sounds the present value is the worth of some amount of money received in the future today. On the flip side of present value is future value. As you may guess future value represents the value of some amount of money in the future based on the value today.
Now there are equations that accompany the present value and future value, but I think the intuition behind the ideas is more important at this point than the equations themselves.
- Interest Rate: The cost of borrowing an amount of money. It is usually expressed as a percentage of the money borrowed (Ex. A 5% monthly interest rate on $100 would result in a payment of $5 per month)
- Present Value: The current worth of a future sum of money.
- Future Value: The worth of an asset or cash at some point in the future
- Asset: A resource with economic value (ex. Cash, land, house, etc.) Another way to think of an asset is something you own.