There are different ways to pay for goods and services, and at some point, you may need credit in your life. Very few people would ever buy a home, buy a car, start a business, or go to college without credit.
- An important financial management skill is knowing how to handle credit and debt without blemishing your credit record.
What is Credit?
Credit is a transaction in which the borrower receives goods, services or cash and agrees to repay the lender at a future date, normally with interest.
- Credit enables people to obtain and use money that they do not currently have. DEBT is the amount you owe.
When someone is given credit in the form of a credit card or a bank loan, the lender will first assess your CREDITWORTHINESS. There is a trust that the person will pay back the money borrowed with interest in a timely manner.
Become familiar with the cost of credit cards.
What does a lender expect in return for the use of borrowed money?
- A bank that lends you money to buy a home expects the loan to be repaid on a payment schedule, paid on time, with interest and fees added in.
- That’s why purchases bought on credit cost more due to interest charges and fees.
There is the downside to overusing credit, especially CREDIT CARDS.
- Consumers might be tempted to overspend, committing too large a share of future earnings for debt repayment and risking a possible poor credit rating.
Credit card debt can be particularly dangerous because of its high interest rates and the low minimum payments allowed by credit card companies.
- For example, if you owe $1000 on your credit card at 17% APR, it will take you 57 months to pay off your debt if you make the minimum allowable monthly payments (approximately $25 per month). In that time, you will have paid $451.55 in interest charges.
- That’s why the best strategy for credit card debt is to make the biggest monthly payment you can handle and keep repeating that until the debt is gone.
Your Credit Report and Credit Score
Before a bank or other lending institution will make a loan or issue a credit card, they will want to know that the person borrowing money will repay it.
- The lender will assess your creditworthiness will be based on your CREDIT REPORT and CREDIT SCORE.
Your credit report is a record of all your credit activities over several years. A poor credit report reflects on your creditworthiness.
- There are three major U.S. agencies that operate credit-reporting businesses, Experian, Equifax, and TransUnion, that maintain and update the information about your use of credit on your credit reports.
- These agencies sell your information to banks, mortgage companies, credit card companies, employers, department stores, small businesses, etc. Know your rights about how credit reporting agencies can use your information.
- The consumer reporting agencies are required to provide every consumer with a free copy of his or her credit report, upon request, once every 12 months.
The information on your credit report is converted into your credit score.
Your credit score, commonly known as a FICO Score is a numeric value compiled from information in a credit report using a standardized formula that ranks the risk of a person defaulting on repayment per the person’s credit history.
- Possible credit scores and what is considered high and low:
- Excellent/very good credit score: 700 to 850
- Good credit score: 680 to 699 (Average American score is 682)
- Average/OK credit score: 620 to 679
- Low credit score: 580 to 619
- Poor credit score: 500 to 579
People with good credit scores can obtain more favorable interest rates on credit cards and loans and subsequently pay less for the credit they use.
- A poor credit score can mean a lack of credit opportunities or even the loss of a prospective job or rental opportunity