Credit: A Tool for Your Future

Are you wondering why you should start thinking about credit? Have you always thought of it as something to worry about later in life? Think again. Just like planning for college early, planning to establish a good credit history can be a big help to you in the future. Credit is a great tool and, if used correctly, it can help you with everything from buying a new outfit to buying a car, paying for college and getting a job.

All credit works in basically the same way: Someone agrees to lend you money and you agree to pay them back. But there is a cost for borrowing the money – interest. Usually, on credit cards (and on some loans) there is a short period of time during which you can pay back the entire amount of money you borrowed and not pay interest. This is called a grace period. Once you go past the grace period, interest begins to be charged to your account. Before taking out a loan or signing up for a credit card, it’s always important to figure out what interest rate you will be charged. If the interest rate is 20 percent annually that means that every time you buy something that costs $100 and wait one year to pay it off, you will be paying an extra $20 for your purchase.

If paying more than the sticker price for a purchase doesn’t sound good to you, you’re not alone. But credit can be a valuable financial tool. Credit is sometimes easier and more convenient than paying with cash. It can also prove useful in an emergency situation. Credit generally offers more consumer protections than paying with cash. And finally, unless you have very large sums of money saved up, you’ll almost certainly need credit to purchase a car or a house.

In order to get a loan, a credit card, a lease on an apartment or any other kind of credit, the person lending you money has to be able to tell whether or not you’re credit worthy. There are three basic areas lenders will consider before extending credit to you.

Capacity – Can you repay the debt? Do you have a job? Do you have other debts?
Character – Will you repay the debt? Have you used credit before? Do you pay your bills on time?
Capital – What if you don’t repay the debt? What do you own that has value and could be used to repay the debt? Do you have a house, a car or a savings account?

Lenders find much of this information about you in your credit report. To learn what your credit report means to you see the related article in this newsletter on credit reports.

The trick to using credit is to use it wisely. The more careful you are to use credit responsibly, the more eligible you will be for additional credit, as well as better interest rates and terms.

Some Helpful Stuff:
Tip: Don’t be lured by free gifts when applying for credit cards. Only apply for cards with good interest rates and payment terms you agree to. If you sign up for a card because of a free baseball cap you could end up getting a bad deal. Also, having too many cards won’t look good on your credit report.

Tip: Always remember that using a credit card is just like taking out a loan and make sure you are able to pay the bill when it comes in the mail. Credit is not free money.

Tip: Start good financial habits now so that when you get a credit card or a loan, you already know how to manage credit.