Understanding the Basics of Credit

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Credit is a convenience and a privilege. It allows you to purchase big ticket items on an installment plan, take out an auto or home loan – or buy almost anything your heart desires without having access to cash.

How credit works:

Credit is simply a promise to repay creditors for goods and services you’d like to purchase now – with interest charged on top of the initial sum borrowed later. Repayment can be paid in full or in monthly installments until the debt is paid back. It can be classified as either secured or unsecured.

Secured credit is a loan or extension of credit that is secured with collateral. If you don’t make your payments the item can be repossessed by the lender to help recoup all or some of the losses if you don’t pay. These loans typically offer a lower interest rate since the loan is backed up by collateral.

Unsecured credit is a loan in which the lender is promised repayment without any collateral to recover in case of non-payment. Because there is no way to recoup their losses, banks and lending institutions may charge a higher interest rate and an established credit history is normally required.

Advantages of credit:

There are a number of advantages to using credit vs. cash or checks:

  • Convenient, Hassle-free Shopping
    When making purchases with a credit card, the transaction is simplified by eliminating the need for cash, checks or additional identification. The use of credit allows you to take advantage of sales even though you may not have the cash on hand. With the high volume of consumers purchasing on the internet, a credit card is absolutely essential as it is the only way most merchants will accept payment. Purchasing with a credit card also simplifies and speeds up catalog or phone ordering.
  • Emergency Protection
    The ability to borrow on credit is a source of security that is especially beneficial during hard times. Credit allows you to meet nearly any emergency, such as sickness or unexpected repairs with confidence, knowing that your financial obligations will be met.
  • Simplified Budgeting
    Purchases made with a credit card can be repaid on a schedule that fits your budget. Credit card statements organize expenses for tax purposes and reduce bookkeeping from month-to-month.
  • Numerous Travel Benefits
    A credit card is essential for car rentals, airplane ticket purchases, and hotel reservations. Whether you’re across town or on another continent, a credit card is the universal guarantee of your good financial standing. If you are away from home without cash, you can receive a cash advance or buy traveler’s checks with a credit card. Places that are suspicious of personal checks often take credit cards. Check with your credit card provider for additional travel, death, theft, auto or personal property protection benefits that may be a part of your plan.

About your credit report:

Be aware that your credit history is recorded and reflected in your credit report. Three major credit agencies, Equifax, Experian, and TransUnion, collect and report information about your borrowing habits from lenders and credit card companies to determine your level of risk. Your credit report demonstrates to potential lenders how you handle debt and helps them to determine whether or not to approve you for a new credit card or other loan application. A good credit report can earn you better annual percentage rates on your credit cards or lower interest rates on home or car loans.

Maintaining a good rating is essential, if you ever need to borrow from a lender in the future. Missing or making late payments will affect whether you are approved for a loan or credit card application. Landlords will look much more favorably on an applicant who has a good credit rating and often will ask for a smaller security deposit. Employers consider a potential employee with a good credit rating likely to be more responsible, be free of the stress associated with credit problems and less likely to embezzle or be involved in other crimes against the employer. Your credit report may also be used when you apply for auto / homeowner’s insurance, or even a mobile phone.

* Click here to find out how to start building a good credit history.