Topics on this page
- What is Credit?
- How Can You Control Your Credit and Avoid Debt?
- What Is Wrong With Just Paying the Minimum Payment?
- Calculating the Interest on a Credit Purchase
- What About Using the Cash Advances on Your Credit Cards?
- What Affects My Credit Rating?
- How Do I Maintain a Good Credit History?
What is Credit?
Credit is the privilege to borrow money and obtain goods in the present based upon a promise to make repayments in the future. Credit is not a right but a privilege that can be lost if it is not used responsibly. When used properly, credit is an ideal financial tool. When used foolishly, credit can cost an exorbitant amount of money in interest and fees. Misusing credit can hurt your ability to purchase homes or cars, as well as endanger future financial stability. There are a variety of different types of credit, each carrying with it different privileges and interest rates, such as charge accounts, car loans, student loans, and home mortgages.
How Can You Control Your Credit and Avoid Debt?
You can benefit significantly from the convenience of credit. Credit cards offer benefits like frequent-flyer miles and cash-back bonuses. They are especially useful for large purchases, emergency situations, identification, reservations, and protection from fraud. Unfortunately, consumers misuse credit cards by using them beyond their financial means. Misusing credit can result in costly interest payments and late fees, impulse buying, overextended lifestyles, and unnecessary, stress such as harassing telephone calls from collectors.
What Is Wrong With Just Paying the Minimum Payment?
Making just the minimum payment on a credit card is rarely a reasonable financial move. Minimum payments make only a very small dent into the original amount borrowed (called the “principal”).
For example, assume that you are $5,000 in debt on a credit card that carries a 17 percent interest rate. The creditor requires only a minimum monthly payment of 2 percent, or $100. Of that $100, a mere $29.17 would be applied to the principal if you made the minimum monthly payment. At that rate, it would take nearly 30 years and cost thousands of dollars over the principal amount for you to pay off the debt. The best strategy is to pay enough toward your balance that your principal will decrease faster than your interest will grow.
Calculating the Interest on a Credit Purchase
Have you ever wondered how much you are actually spending when you choose to pay with credit instead of cash? If it takes you 12 months to pay for a new TV that you purchased for $1,000 using a credit card charging you 18% interest, then you will end up paying an extra $100 in interest charges. Various online calculators are available to calculate credit card interest.
What About Using the Cash Advances on Your Credit Cards?
Cash advances (getting cash through a credit card) are not free money - you must pay back the amount of the cash advance at a typically high interest rate, as well as pay a cash advance fee. If any payment is late, late fees or higher interest rates may also apply. Taking out cash advances to pay off existing credit card balances is not a solution to your credit woes. This method of paying bills is one of the worst financial decisions you can make, because it compounds the problem. You will ultimately end up paying off the new debt at a higher interest rate, and lose even more money.
What Affects My Credit Rating?
If you ever apply for a charge account, a credit card, a car loan, a personal loan, or a mortgage, your credit history will be a major factor considered by the creditor in reviewing your request. It may even affect your ability to get a job or buy life insurance. A good credit rating is an asset. If you want a good credit rating, you must use credit with discretion. Limit borrowing to your capability to repay and live up to the terms of your contracts. Be proactive in establishing and maintaining a good credit rating.
There are three major national credit reporting bureaus collecting credit information on consumers: Equifax , Experian , and TransUnion. These agencies compile data on millions of consumers. From these files, a credit bureau can produce for a revealing report about your past and present credit activity that can be viewed by any subscribing creditor.
Banks, finance companies, merchants, credit card companies, and other creditors regularly send credit agencies reports on their customers that contain information about the kind of credit given to you, the amount and terms, and your paying habits. Credit bureaus collect some information from other sources as well, such as court records.
Each time you buy on credit from a reporting retailer or take out a loan at a bank, finance company, or other reporting creditor, a credit bureau is informed of your account number, the date, amount, terms, and type of credit. As you make payments, your file is updated (usually monthly) to show the outstanding balance, the number of payments, and amounts past due and the frequency of payments received 30, 60, or 90 days late. Your record may indicate the largest amount of credit you have had and the maximum limit permitted by each creditor.
NOTE: Each inquiry about your credit may be recorded; any lawsuits, judgments or tax liens against you may appear as well.
How Do I Maintain a Good Credit History?
Pay all bills on time. Paying promptly is a key factor in assessing your credit rating. Follow up all communications in writing and keep copies of your correspondence.
Do not overextend yourself. Managing several accounts in which you are current with payments will help you maintain a good history. However, make sure you are able to meet all payments promptly by only charging as much as you can afford to pay in one month's time. Borrowing more than you are able to repay in a consistent and prompt fashion will reflect negatively in your credit history.
Open and maintain credit. Open credit in your own name if you are married. If you have your own source of income, either from full- or part-time work, using your own name on an individual credit account will assist you in establishing and maintaining a good credit history.
Review your credit file periodically. The Federal Fair Credit Reporting Act allows you to examine your credit file to ensure that the information is accurate and current once per year for free. It is advisable to undertake this review every year. Learn more about how to get a copy of your credit report.
If you believe the information is inaccurate, contact the Credit Reporting Agency immediately.
Correct any mistakes on your credit card bill/statement and credit report. The Federal Fair Credit Reporting Act protects you if your credit report or credit card bill/statement has a mistake on it.