Understanding Credit

You're probably familiar with using a credit card. Just tap, swipe, or insert to pay: it seems like magic! But understanding the concept of credit goes deeper than just your one-swipe purchase. This post will break down credit in a simple way for beginners to understand.

What is Credit?

Credit is an agreement to borrow money or acquire goods now, with the promise to pay it back later, typically with interest. In other terms, credit allows you to use money that you currently do not have, as long as you pay it back.

How do Credit Cards Work?

When you use a credit card, the issuer (the bank) pays the merchant on your behalf. This creates a balance that you must pay back. If this balance is paid back by the due date, it is interest-free. If not, interest is charged at high rates.

Good vs. Bad Credit

When talking about credit, it is important to establish good credit. To establish a good credit history, make sure to pay all bills on time and keep your credit card balance low. Ideally, you should only use under 30% of your total available credit limit. Do not max out on credit cards. Payment history is the biggest factor in your credit score, so make sure to pay back credit on time, every time.

The Importance of Good Credit History

Lenders, landlords, insurance companies, and potential employers are examples of people that may check your credit history. Having a good credit history makes a big difference when you apply for a loan, look for a job, buy a car, rent an apartment, etc. A higher credit score demonstrates responsibility, directly impacting your interest rate on mortgages, whether you are approved for a loan or not, and making it easier to rent apartments. Make sure to start developing a good credit history now; your future self will thank you!

How to Build Good Credit History as a Teen

Being a teen, there aren't too many opportunities to build your credit history right off the bat. The best way to build credit is to have your parent add you as an authorized user on their credit card. This way, your credit score can benefit off of their good credit history without you having to do anything. In the US, you must be 18 to legally open a secured credit card.

Understanding Credit Score

A credit score is a number from 300 to 850 that predicts how likely you are to repay your debt based on your credit history. This is what lenders and employers will typically check to ensure your responsibility. The higher the number, the better the credit score. A "good" credit score is typically classified as above 670. Businesses use your credit score to determine whether to give you credit and what the terms will be.

Credit Reports

A credit report is essentially a summary of your credit history. There are three nationwide bureaus: Equifax, Experian, and TransUnion. Since each bureau gets its information from different sources, it is important to ensure the information in your credit report is accurate. A credit report includes:

• Personal Information

• Credit Account History

• Public Records (bankruptcies, foreclosures, liens, and civil judgements)

• Credit Inquiries (a list of lenders and companies that have requested your credit report)

• Collections (overdue payments that have been sent to a collections agency)

Credit reports do not contain your credit score, but rather the information needed to calculate it.

Types of Credit

There are three main types of credit:

• Revolving Credit

  • A line of credit that can be used, repaid, and used again, such as credit cards.

• Installment Credit

  • A loan for a specific amount, repaid through fixed monthly payments over a set period, such as mortgages

• Open Credit

  • Credit that requires the balance to be paid in full at the end of each payment cycle, such as utility bills

Conclusion

As a teen, it is important to understand credit and start building it now for a more successful future. In a couple of years, you will be buying a car, looking for a job, applying for a student loan, or renting an apartment. Maintaining a good credit history is vital throughout all of this. Remember: pay on time, every time for a brighter, more financially-stable future!