If you need some money, getting credit can be a fast and effective option. However, many people avoid this possibility, as they don’t like going into debt. While sometimes that attitude can be very beneficial, in some other cases, it can backfire. Don’t be scared of credit. Instead, be wise about it.
What is credit?
In financial parlants, credit is the same as a loan (or, in some contexts, it’s a person’s ability to secure a loan). Credit means you borrow money from a bank, and you pay it back at a certain interest rate.
When you want to get a loan, you need to be qualified for it. Banks will check your credit score. If you want to know what your credit score is, check out this free online tool - check my credit score.
What goes into creating a credit score?
Your credit score lets potential creditors know about your financial behaviour, past and current. The two key factor that go into compiling a credit score are:
- Past bill payments - Make sure you pay your bills on time, especially bills from large companies, like utility companies or car dealerships, that are likely to report delinquent payments.
- Credit Usage - This is a percentage of how much of your current credit line you are currently using. Creditors don’t like this percentage to be above 30%.
What are some common myths about your credit score?
There’s a lot of information online about your credit score. And not all of it is accurate. Here are a few common, yet incorrect, notions of your credit score.
Checking My Credit Score Will Negatively Affect it.
This is not true. Your credit score is negatively affected whenever you are late in your payments or if you are refused a loan. If you simply check your score to see where it’s at, this will neither help nor hurt your score.
Closing a Credit Card Will Improve My Credit Score.
In fact, the opposite is likely true. Creditors are not concerned about how much credit you have (how many credit cards you have) but rather how much of your credit limit you use. This is known as credit utilization and is a main factor in your credit score.
If you have a credit card that you are not using, this will lower your credit utilization (the percentage of available credit you are using). Having low credit utilization is favorable. Thus, when you close a credit card you aren’t using, inadvertently, you are lowering your available credit and increasing your credit utilization.
Go ahead and close your credit card, but make sure this move doesn’t raise your credit utilization too much. (Keep your credit utilization under 30%.)
What are the different types of credit?
There are several types of credit available: personal loans, credit cards, student loans, and car loans are some of the most common forms of credit.
These are generally unsecured loans – the lender doesn’t require any collateral (for example, your house) as insurance for the loan. The most common reason people take out personal loans is because they need some money urgently – for example, to pay for medical bills or to cover an unexpected expense at home, like a broken refrigerator or roof repairs.
In most cases, personal loans have a fixed term (the earliest repayment date). Therefore, you need to plan ahead when taking out such loans. Otherwise, you may end up paying more than expected.
If you go to college or university and want to pay for your tuition expenses or rent with a loan, student loans is what you need. There are federal student loans and private student loans – all depending on what you prefer – and federal student loans are often subsidized.
Credit cards and store cards
Both of these options allow you to use borrowed money for whatever you need and with no collateral. The only difference between them is that while credit cards are issued by banks or other financial institutions, store cards are issued by individual stores or retailers (such as clothing stores). Store cards usually have much higher interest rates than credit cards do (but credit cards also have very high interest rates if the bills are not paid in full when due).
If you want to finance a new car purchase, car dealers let you use their financing options. (In fact, this is how they make most of their money. If you plan to pay all at once - cash, no credit - do not tell the salesperson upfront you are paying cash. They will then quote you a higher price than they would quote if you were to use their financing options.)
Cars have a high cost of depreciation compared to other kinds of assets; so make sure that you really need that car before getting it financed.
Can I get a loan or credit card without a good credit score?
Yes, there are several alternatives – but they can be quite costly. For example, if your credit score is not good enough for a bank loan or credit card – which happens when your score is lower than 620 – then you can get a secured loan instead. Your security will be something valuable (for example: your house) that the lender will use as collateral for the loan. These kinds of loans usually have higher interest rates than unsecured loans do.
Getting a payday loan is another option; they usually have very high interest rates (around 30%). However, they can be useful in the case of an emergency.
Check your credit score. (Checking won’t negatively affect your score.) Make sure you pay your bills on time, and don’t use all of the credit you have available to you. This will significantly reduce your credit score.
Be smart. Plan ahead. And keep your options open.