What is credit?
Credit is defined in several ways. One is the amount of money you are approved to borrow from a lending institution. With this approval comes an agreement to repay it with interest, additional fees that can be applied, and a certain time to pay back the complete amount with interest. Credit is classified as your borrowing reputation. It paints a picture to the lenders of your payment history and provides the lender with information regarding the likelihood of you repaying the borrowed amount with interest. They put on a risk ladder, the lower you are on it the more money they are likely to lend to you as you are considered a good borrower in their eyes, the higher you are on the ladder the harder it will be for you to get a loan and even if you do, the interest rate will be high because of the extra risk they are taking by lending you money.
Using Credit To Your Advantage
Credit is essentially a financial tool, if you learn about credit and how to increase your score you will be ahead of the curve. Credit is woven into the fabric of the American way of life from a simple credit card to an auto loan to a home mortgage loan. Cashless transactions are soon becoming the way of the future, and credit cards are among the most prevalent. Understanding credit is important to use credit to your advantage and prevent the common financial pitfall known as debt.
Four Major Forms of Credit
You can borrow money up to a particular amount with this type of credit. A credit limit, or the maximum amount you can borrow, is set by the lending organization. The borrower in a revolving credit account rotates the balance from month to month until it is paid in full. Any revolving balance is subject to interest charges. As the money is repaid, the difference between the maximum credit limit and the current credit limit shrinks as you make payments. Revolving credit is most commonly seen in credit cards.
This type of credit is frequently confused with a revolving credit card but charge cards are known to be more advantageous in not building credit card debt, unlike credit cards that allow for revolving credit. Charge cards don’t typically operate as regular credit cards as they require you to pay the complete balance every month. Charge cards usually don’t have a spending limit as well as no interest rate. Failure to pay the full amount by the end of the month may result in penalty fees. An example of a well-known charge card is American Express. Charge cards are known to be more advantageous in not building credit card debt. Charge cards are known to charge high annual fees while you can find credit cards with no annual fees and decent interest rates.
Installment credit entails a fixed loan amount, a fixed monthly payment, and a fixed payback period. Interest rates are set in advance and factored into the monthly payments. Home mortgages and auto loans are two common types of installment credit arrangements.
Installment credit is also typically secure. Secure credit requires security for the lender. The borrower must provide collateral to guarantee loan repayment. If the borrower fails to repay or defaults on the loan, the lender may confiscate the collateral. A home is an example of collateral on a mortgage, and a vehicle on an auto loan. If the borrower were to default, the home or vehicle would be repossessed.
Non-Installment or Service Credit
This form of credit allows the borrower to pay for a service, membership, etc. at a later date. Generally, payment is due the month following the service, and unpaid balances will incur a fee, interest, and/or penalty charges. Continued non-payment will result in service cancellation and can be reported to the credit bureau, affecting your credit score. Service or non-installment agreements are very common in our everyday life. phone, gas and electricity, water, and garbage are all examples of service credit.