March is National Credit Education Month, so what better time to brush up on your knowledge? A little mysterious and sometimes confusing, credit represents the ability to borrow money assuming it will get paid back in the future, usually with interest. It’s an agreement between a lender (i.e., a bank or merchant) and a borrower based on the individual’s creditworthiness.
Being creditworthy or “having good credit” enables you to borrow with more competitive terms (i.e., lower interest rate and eligibility for more funds).
Importance of Credit
Odds are, most of us will need to borrow some form of credit during our lives, and that’s where your credit score comes in. Lenders use your credit score to determine whether or not they should offer you money, how much, and at what interest rate. Typically, the higher your score, the better the terms you’re offered – and the lower your score, the less attractive the terms.
Credit scores are based on weighted factors, including your payment history and length, the amount you owe, and the type of credit you’ve used in the past.
Establishing and maintaining good credit can be tricky, but it’s important to think about, even if you aren’t planning to borrow in the near future. After all, most people can’t pay a large sum of cash upfront for their car or home.
Types Of Credit
Installment credit is the most popular type of credit and includes car loans, personal loans, and mortgages. With an installment loan, you borrow a specified amount of money at once and make regular payments anywhere from a few months up to multiple years.
Revolving credit allows you to borrow, pay off, and borrow again on the same loan up to a predetermined dollar amount. You pay off what you borrowed at regular intervals and accrue interest if you don’t pay in full. Examples of revolving credit include credit cards, home equity lines of credit (HELOCs), and personal lines of credit.
Best Credit Practices
It takes diligence to maintain good credit by staying on top of payments, keeping your credit utilization low, and avoiding common credit traps. Here are some general tips for using credit.
- Pay off your credit card in full each month.
- Don’t borrow more than you need.
- Avoid closing long-held accounts.
- Try to pay a minimum of 20% down when purchasing large items. The more you can put down, the better!
How you use your credit now can have a long-lasting effect on your financial life. Good credit gives you the freedom to buy things you couldn’t otherwise. Lower credit can quickly become unmanageable and can affect your capacity to borrow.