The Rules of Debit & Credit

In the world of accounting, debit and credit are two of the major players. It's important to understand that debit and credit work against each other on the balance sheet and that both the debit and credit processes are required to make accounting function like it is supposed to. It is equivalent to how addition and subtraction make the world of mathematics go round.

Real Accounts

A real account is an account that is reported on the balance sheet, which is where the assets, liabilities and equities of the business owner are recorded. The reasons these types of accounts are labeled as "real" is because they exist on a continuous and permanent basis.

So if you buy office furniture for your business, the debit rule states that the furniture coming into the business affects the real accounts on the balance sheet. In this case, the furniture account of the company is debited because the rule states that you "debit what comes in."

In another example, if you were the company selling the furniture to Ms. Smith, then your balance sheet would look different. In this case, you as the furniture seller would credit your real accounts area of the balance sheet because the credit rule states that you credit "what goes out."

To determine whether a real account is a debit or credit, you have to stop and think about whether the item is coming into the company (debit) or going out of the company (credit).

Personal Accounts

Personal accounts are related to natural persons or representatives of the company or organization. To determine whether a personal account is debited or credited, you have to first determine whether the "person" is giving money to the organization or receiving (or benefiting) from the organization.

The rule states that you debit the receiver and credit the giver.

So if the business pays Mr. Smith $1,000 in cash, then the Mr. Smith account is debited and so is the cash account because that is where the cash was taken from to pay Mr. Smith.

If the business were buying furniture on credit from the ABC Furniture company, you would credit the ABC Furniture account because it is "giving" the furniture to the business.

Nominal Accounts

A nominal account is registered on the income sheet of the business, which is where the income and expenses of the business are recorded for a specific period of time.

There are two rules for nominal accounts. The first rule states that all expenses and losses to the company are recorded on the income sheet as debits. The second rule states that all income and gains to the business are recorded as credits on the income sheet.

Using these rules, if the company pays its employees for work performed, the cash account, which is the real account, and the wages account, which is the nominal account, are both debited as losses or expenses to the company.

On the other hand, if the company receives a commission payment from a company for selling its goods, then the payment is recorded as a credit to the bank account, which is the personal account of the business, and to the commission account, which is the nominal account of the business.

Two Effects

Another primary rule of accounting is that there are always two accounts effected by a transaction. This means that if one account is credited then another account has to be debited. This is what has to happen to keep the numbers balanced.

So let's say that your company is purchasing office furniture from the ABC Furniture Company on credit (rather than paying in cash). Since you are buying furniture for the company, it is coming into the company and therefore is treated as a debit to the goods account. A credit is recorded to the ABC Furniture Company account because you credit the giver.

Debited and Credited Accounts

There are some cases where an account is credited but then in another scenario the account would be debited. For example, a cash account would be credited when a cash purchase is made, but the same cash account would be debited if a cash sale is made.

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When Do Mortgages Fall off Credit?

The primary way in which the creditworthiness of an individual is measured is through his credit score. This score, which is calculated using both positive and negative information contained in the individual's credit report, provides lenders an indication of the likelihood that he will pay back a loan on time. The record of a person's mortgage will stay on the credit report for its entire life, although some information will count only for a limited time.

Credit Reports

A credit report includes all information reported by lenders and acquired from public records that directly relate to an individual's credit history. This can include a record of any loans that the person has taken out, as well as whether she has paid back these loans on time. The exact terms of the loan will not be included on the record, but the date the loan was taken out will be noted, as will its size.

Mortgages

All home loans are listed on a credit report, starting when the loan is first reported to the credit reporting bureau by the lender who issued the loan. The record of the mortgage is never taken off the credit report -- it will remain on the report for the entire time that the report exists and the individual continues to take out credit. However, only some information about the mortgage will remain visible to creditors.

Positive Information

According to Experian, one of the three largest credit reporting bureaus, all positive information on a person's credit report can remain on the report indefinitely. So all information that boosts a person's score -- for example, records of loans that were paid on time -- will not be taken off a person's report. If a mortgage is taken out and paid off completely, with each payment made on time, this information will forever aid a person's credit score.

Negative Information

However, according to federal law, negative information can remain on a credit report for only a limited period of time, after which it must be removed and can no longer affect the person's score. If a person misses a payment on a mortgage, this record of the missed payment, which will pull down the person's score, must be struck after seven years, after which time it will no longer harm the credit rating.

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How to Open a Business Account With Bad Credit

Opening a business bank account with less than stellar credit is easier than it once was. Even if your bad credit includes being reported to ChexSystems for writing bad checks, the odds are still in your favor for opening a business account. The best actions are to be honest, do careful research and move forward.

Instructions

1

Incorporate your business. By registering your company, you will receive a tax identification number that can be used to open a business bank account. It removes business assets from your personal accounts and protects them from creditors. When opening a business account, all banks require a tax identification number to comply with federal regulations.

2

Contact banks who open business accounts for people with bad credit. Call and ask to speak with the bank manager. Explain your bad-credit situation and the circumstances surrounding it. Some examples of banks that open high-risk business accounts include Bank of America, SunTrust and Wells Fargo. Apply in person or online to receive an instant answer.

3

Visit your local credit union. Inquire about opening a business account. Credit unions are less likely to use check verification systems and credit reports. Thus, most are willing to work with bad-credit situations. Ask their requirements, fill out an application and wait for your status.

4

Open a savings account. Most banks let customers open savings accounts with less-than-perfect credit. It is possible to open a savings account that functions as a checking account. After establishing a positive account status, ask to open a checking account.

5

Shop around. Call different banks and ask about opening a business bank account. Visit the branch where your personal accounts are held. Ask to open an account based on your ability to maintain a certain balance. Pledge company assets as collateral. Speak to the bank manager and explain your situation.

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The Snowball Effect of Spending Down Your Debt

The snowball debt payment is a system of debt reduction popularized by financial expert by Dave Ramsey. It advocates paying off your smallest debt first and working your way up to the largest debt. It has many supporters, but it has also received some criticism for ignoring interest rates.

How it Works

To use the snowball effect, order all your debts from smallest to largest. Each month, make the minimum payment on all the debts and then spend as much extra as possible to pay off the smallest debt. Once it's paid off, you then turn your money to the next debt on the list. It's called a snowball because as each debt is paid off, the minimum payment is added to the money used to pay off the next debt. Thus the amount of money available to pay each individual debt increases as you progress.

Advantages

The advantage of the snowball effect is that the quick payoff from targeting smaller debts provides motivation to continue aggressively paying down your debt. The system provides a steady flow of such victories to help you stay motivated.

Criticism

The main criticism of this approach is that it ignores interest rates when determining which debts to pay off first. Leaving larger, but higher interest rate, debts for last can cost you a lot in interest. Especially when credit cards can have interest rates of 20 to 29 percent. A $5,000 credit card balance at 25 percent would cost you more than $1,300 in interest in a single year. The same amount total made up of smaller loans at 8 percent interest would only rack up $400 in interest each year. So you can see, paying off higher interest loans can make a large difference in the amount of money you'll ultimately spend paying off your debts.

Alternatives

One obvious alternative is to change the order you pay off your debts to put the highest interest debts first. Another option is to consolidate your debts at a lower interest rate. This can be done by seeking a personal loan from the bank and using that loan money to pay off the others. This will give you one large loan to pay off, reducing the number of bills you have to keep track of and chances that one gets forgotten. Yet another option is to move your credit card debts to a new lower interest card, or use an introductory rate to save money while you pay it off. Just be careful that you don't get hit by interest higher than the original when the introductory period ends. Whichever path you choose, be sure that once you pay off those debts you keep your spending to what you can afford.

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What Is the Best Way to Consolidate Debt Into One Payment?

Consolidating your debt into a single payment can provide you with the ability to potentially pay it off faster. Only having to worry about one payment every month is also attractive for many people. One of the best ways to consolidate your debt into a single payment is to refinance your existing mortgage.

Function

With this process, you will take out a new mortgage loan from a mortgage lender. You can take the money from this loan and use it to pay off your existing mortgage. You then take the money that is left over and use it to pay off your credit accounts. At this point, you will have only one payment to make every month in the form of a mortgage payment to your new lender.

Interest Rate

One of the primary advantages of using a refinance to consolidate your bills is that you can get a low interest rate. Interest rates on mortgages are generally cheaper than what you could get from a home-equity loan or from a personal loan. The interest is much cheaper than what you could get from a credit card. By getting a lower interest rate, you can save a substantial amount of money over the life of your loan.

Taxes

Refinancing your mortgage and using the money to pay off your debts can also provide you with a tax advantage. If you itemize your tax deductions, you can deduct the amount of mortgage interest that you pay from your taxable income. This means that the interest you pay on your debts is actually tax deductible with this structure. When you pay a personal loan or a credit card interest, you do not receive any tax deduction.

Time Frame

When you refinance your existing mortgage, you will get a long period of time to repay your debts. Most mortgages are either 15, 30 or 40 years long. By getting longer to pay off your debts, you lower the monthly payment. At the same time, you have to deal with debts for much longer than you would with other loans.

Considerations

When shopping for a refinance, you need to take into consideration the amount of money that you have to pay in closing costs. Refinancing always involves some type of closing costs and if the costs are too high, it may be to your advantage to look elsewhere. For example, you might be able to get a home equity loan without paying the closing costs. The disadvantage to that scenario would be that you have to make a payment to both your home equity lender and your mortgage lender every month.

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Debt Payoff Strategies

From credit cards to home mortgages, most people owe some form of debt. Your credit score can affect getting the car or home you want and even whether you are eligible for certain types of employment. Paying off outstanding debt is the best way to raise this score. Here are a few strategies that will aid in paying off those debts.

Pay off Lowest Amount First

One method of reducing debt is to pay off the smallest balances first. This method is results oriented -- as you pay off a small debt, you can eliminate that creditor from your monthly list. Eliminating any debt from your budget is liberating and grants a sense of empowerment if you are struggling with debt. Financial adviser and radio talk show host Dave Ramsey calls this approach the "debt snowball" (see Reference 1). Paying off the smallest debts first will enable you to see actual results and keep you motivated toward paying off the next largest debt.

Paying off Highest Interest Rate First

Another effective debt strategy is paying off debts with highest interest rates first to save money in the long run. The more money you can throw at a large sum, the less interest you will accrue. Some interest rates can be as high as 30 percent -- if you are paying only the minimum payment every month, the majority of your payment is going toward the interest. Place as much as you can into your highest interest rate account and pay the minimums on your other accounts and you will see a drastic reduction in your principle.

Consolidating Debts

Debt consolidation is a great tool to aid in debt relief. This method is most beneficial if you have several accounts with very high interest rates. Take these accounts and combine them into a single account with a lower interest rate. While your balance may be high on this new account, you have a lower interest rate, which saves you money. Another benefit is that you no longer have the headache of managing multiple accounts. Continue to focus your extra funds into this account and you will become debt-free and improve your credit score.

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What Does a Debt Arbitrator Do?

Most Americans have debt of one kind or another. Taking on debt is often a necessity to buy a home or finance an education; however, when an individual can no longer effectively manage his debt obligations, he may need to seek professional assistance from a debt arbitrator.

Debt Management

When an individual becomes severely delinquent on his debt obligations he may be faced with the possibility of bankruptcy. During this time, he may seek the advice of a professional debt manager. A debt manager helps the individual determine the best method to manage and, if possible, eliminate the consumers debts. This process includes assessing the debtors income-to-debt ratio. If the debt managers determines that the debtor has the money to pay his debts, the manager may recommend a debt arbitrator.

Arbitrator

A debt arbitrator is a professionally trained negotiator. The primary function of the debt arbitrator is to negotiate with your creditors and lenders to secure a mutually beneficial debt settlement agreement. This consists of convincing your creditors and lenders to agree to let you pay them a lump-sum payment that is usually significantly lower than your total amount of outstanding debt. Unlike a bankruptcy, debt negotiation and arbitration do not become a part of your public record.

Creditors

Creditors and lenders have expenses like any other business. Because of this, most creditors are willing to negotiate with a debtor to receive their money as soon as possible. Likewise, for many creditors the alternative to not negotiating is often bankruptcy, which requires time and money for both parties involved. Debtors who negotiate their own debt often accept the first offer that a creditor makes. This can result in a settlement cost significantly higher than that which a debt arbitrator would negotiate.

Uses

Stricter bankruptcy laws have made it increasingly difficult for debtors to eliminate all of their debt. If you have a relatively small amount of debt and one or two creditors, debt arbitration may not be necessary. If, however, you are faced with bankruptcy and have multiple creditors, the negotiation expertise of a debt arbitrator can save you thousands of dollars in costs and help you avoid the financial burden of bankruptcy.

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