Charge for Long Life
To use credit most effectively, you should buy things that last. Another way of looking at this is to avoid using credit to buy things that have a very short life. A rule of thumb: you should be able to pay off the debt by the end of the item's useful life. People who follow this rule are able to stay on top of their debt. This section is not intended to lecture you about spending habits; rather, you should simply understand the concept about the lifetime value of your purchases.
What's a Long Life?
Before you charge something or apply for a loan, consider how long you'll enjoy the benefits of the item. For example, consider a night out on the town — perhaps some cocktails in a classy setting, a gourmet dinner, a show, and a cab ride. It can be very tempting to use your credit card for a night of luxury. However, consider how long you'll be paying for that one night. You can't relive it except in your memories, but the debt is on your cards.
If you make the minimum payments, it can take decades to pay off a debt. Do you really want to pay for your night out for the next twenty years? What if you want to have another night out? It is okay to splurge on yourself from time to time, but borrowing for things that come and go will get you into a hole quickly.
If you're going to borrow, borrow for things that will give you value for the entire time you make payments on them. A house is a great example. Sure, you have to make payments for many years, and you might never own the thing outright, but you get to live in it and participate in any market appreciation.
Upside-Down Cars
Another example might be your automobile. You sometimes hear that somebody is “upside down” on their auto loan. What does it mean to be upside down? It means the loan amount is greater than the auto's value. If you sold the car at current market prices, you would not pay off the loan balance. This happens when the car loses value faster than the debt is paid down. If you need another car and you're upside down, the only way to get one is to take a loss on your current car and add more debt. Again, you're not getting ahead, you're falling behind.
Now that you know the concept, look at everything you are thinking of charging or purchasing with the help of a loan. Which will last longer, your enjoyment of the item, or your debt? If the debt will far outlive the item, reconsider the purchase.
As with the night on the town, people get upside down on their auto loans due to shortsightedness. Too many auto buyers look at their monthly payment when they consider a purchase. One way to lower your monthly payment is to lengthen the term of your loan. That's fine if the auto will last at least as long as your loan. If it doesn't, your debt outlives the item you purchased.
