Simplifying Credit
Credit is money borrowed, commonly referred to as a loan and it is the promise to pay back the money borrowed with interest.
There are two main types of credit: closed-end and open-end credit. With closed-end credit, you get a one-time lump sum of money. You pay it back with installment payments (ex. car loan) over a set period. The payments and amount of time to pay off the loan are fixed. They will not change. Once the balance is paid in full the account will be closed and cannot be used to borrow more money. Open-end credit is a credit line with a limit that you can borrow against and use as needed. You only pay interest on what you use and as you repay what you borrow, you can borrow from the line over and over again. The interest rate and minimum monthly payments can vary. (ex. Credit Cards)
Credit can also be secured and unsecured. Secured credit is tied to some kind of collateral that belongs to you (i.e., car or home) – The collateral can be taken from you or sold by the lender if you do not pay the credit back. Unsecured credit has no collateral. If you do not repay the debt, the lender sends the debt to collections or sues you in court to force you to pay.
These consequences for not paying are the reason why credit cannot be thought of as free money. Borrowing money or making charges to a credit card always comes with a cost. If you abuse credit, you can wind up with serious debt problems. Debt can destroy your finances and ruin your credit score.
So… Is credit right for you? The first key to using credit the right way is to always ask yourself if you really need a particular piece of credit AND if you can afford to repay the debt. In general, it’s better to pay for things in cash or pay for them using savings. This helps keep debt minimized. Don’t just open credit cards for the sake of having more credit. Only open credit cards when you have a specific need for a specific card. Always try to budget and save for specific goals, like buying your first car or paying for college. This reduces the amount you need to borrow.
However, even if you want credit, you may not be eligible to receive it. There are laws that restrict teens from getting credit on their own until they turn 18 and have a verifiable source of income. If you want a loan or credit card before the age of 18, you need a cosigner. That is usually a parent or guardian, but can also be another trustworthy individual. If you don’t repay a debt on time, it can not only ruin your credit but the cosigners, too!
Once you determine that credit is right for you and that you are eligible, there are a few steps to receive it. Before you apply for credit, you always want to shop around. Always look for credit that has the lowest APR (Annual Percentage Rate) and fewest fees. When you find the credit you want, you apply for it. The lender usually reviews your credit report and credit score to decide if they want to approve you. If you get approved, they give you an interest rate and set terms based on factors such as credit worthiness and income: For loans, your credit score also determines how much you can borrow.