When people use credit, they purchase goods and services now and agree to pay for them later, often with interest. Building a good history of using credit responsibly is an important part of personal financial management.
The Cost of Credit
There are many reasons people use credit. Often, it’s used to purchase things they can’t or don’t want to pay for right now, or to spread the cost of a large purchase out over time. But credit doesn’t come for free.
Anytime you use credit, you need to repay the debt within a timeframe set by the company that gave you credit. Plus, you’ll owe interest, which is the cost of borrowing money. Interest is one way lenders earn money.
Say you put $100 on a credit card. Depending on how quickly you repay that debt, you may owe only $100. But if it takes you awhile—like longer than 30 days—you’ll owe $100 plus any interest added during that time.
The interest you pay depends on the type of credit. For instance, it’s common for credit cards to have interest rates of 20% or higher. But an auto loan for a new car could be closer to 5%. Because cars are a bigger purchase, even a lower interest rate adds up over time.
Before using credit, make sure you can afford both the initial purchase and any interest. Ideally, you’d only make purchases with credit that you could pay off in full before any interest is due. But with larger purchases like a car or home, usually credit is a necessity.
Credit History
There are special agencies that keep a history of how people use credit. When you borrow money on credit and pay it back on time, lenders make a positive report to these agencies. If you don’t pay on time or fail to pay at all, that’s reported too. Then the agency assigns you a number, called a credit score, that represents how reliably you’ve managed credit in the past.
Every time you want to get a new credit card or loan or ask for credit in other ways, a lender will check your credit report to see your credit rating. Lenders are more likely to extend more credit to people without a lot of debt and who have a history of repaying credit.
Just like you’d never want to lend something valuable to a friend who wouldn’t give it back, lenders only want to give credit to people who are reliable and responsible. Keep in mind that even if credit is available to you, it isn’t always wise to take the offer. Not all lenders have your best interest in mind.
Usually, only people over age 18 have a credit report and score. Cultivating good financial habits now helps you be creditworthy in the future.
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