Understanding Your Credit
Credit is the amount of money available for you to borrow. This money has to be paid back with interest within a certain time. Understanding how to responsibly use credit is an important consideration for your Financial Wellness.
Two Types of Credit
Revolving credit (credit cards) can be used over and over. Installment credit (loans) is a fixed amount you borrow and pay back on a schedule. Whether using revolving or installment credit, your payments depend on how much you borrow, the principal amount and the interest (also known as the finance charge, the amount you get charged to borrow money).
Loans should only be used for big-ticket items such as a car, home or college. However, there is an extra cost for the loan you want to borrow. You will be charged an Annual Percentage Rate (APR) based on your credit worthiness — your credit score (explained later).
APR and interest are related. The interest rate is used to calculate the amount of interest charged each period. The APR is figured by multiplying by the number of periods in the year. More specifically, the interest rate includes compounding, while the effective APR includes both compounding and fees.
Tip: The better your credit score, the better offer you’ll get.
Lenders use your credit score to determine whether to extend you credit and at what interest rate. The credit score allows them to evaluate whether or not you’ll pay them back as 35 percent of your score is based on your payment history.
When you apply for a credit card, you are asking a company to lend you money. The card can be issued by a bank/credit union, store or other company (ex. airline). You can charge purchases (up to the card limit) and make payments for the charges at a later date.
However, there is no term that states when the charges must be paid back. If you use credit cards, be smart about what purchases you choose to use a card for as there are additional fees charged in addition to interest.
Annual Fee: This is a fee you pay for having the credit card, usually for cash or travel reward cards.
Late Payment Fee: This is a fee you're charged for making a payment after your due date.
Over the Limit Fee: This is fee for borrowing more than what you are approved for.
Cash Advance Fee: This is fee for withdrawing money through your credit card.
Fees are only one potential disadvantage of using credit cards. Others include:
- The temptation to overspend. Spending $5 for a cup of coffee can be a hard decision to make when you only have $10 in your checking account BUT charging $5 on an approved $1,500 credit card doesn’t sound bad. Being able to spend more than what you have is risky and can put you in dangerous situations.
- It could hurt your credit score if you use the credit card irresponsibly. This also affects your future usage of credit as you would need to pay more in interest due to your past behavior.
Yet, credit cards can be useful when you use them wisely.
A credit report is a statement of information about your credit activity. It shows the status of all of your credit accounts from businesses that have given you credit or loans. It will describe the amounts of each loan or the limit for each card. It will also include how often you paid on time and the amount you have paid. Additionally, it will show if you paid late or missed a payment. You can view a sample credit report from Experian, one of the three major credit reporting agencies.
Places to get your free credit report:
AnnualCreditReport.com: This is the only authorized website for the free annual credit reports that you are guaranteed by law.
Credit Karma: This website provides receive free credit reports and credit scores. It also has an app that will let you keep track of your account on the go.
Smart Use of Credit Cards
Pay attention to your spending when using credit cards as it's easy to spend more money with a credit card than cash. Think about your budget and how much money you have for your monthly credit card payments.
You can adopt some of these practices to maintain a good credit history while in college.
- Know what you owe AND when you owe it! It’s important to check your account statement to see the amount you have charged and when your bill is due. Add it to your calendar and make sure you have funds to pay it.
- Make sure you pay as much as possible, not only the minimum payment. If you only pay the minimum payment, then it will take you longer to pay off your credit card.
Use this credit card calculator from Bankrate see how long it would take you to pay off our credit card — especially if you are only making the minimum payment.
A credit score is a measure of your financial health. Credit reporting agencies use a mathematical formula — called a scoring model — to calculate how likely you are to pay your loan back on time. Your score depends on the data used to calculate it and can vary based on factors including the source of your credit history, the type of loan you're applying for and even the day it was calculated.
Experian offers this explanation on how your credit score is calculated:
35 percent: Payment history
30 percent: Amounts owed on credit and debt
15 percent: Length of credit history
10 percent: New credit
10 percent: Types of credit used
Although federal law allows you to request a free copy of your credit report, your credit score will not be on it. They are two different things. You can get a credit score from your credit card company, oftentimes for free as it could be reported on your monthly statement. Additionally, you could purchase your score directly from the credit reporting agencies.
Lastly you can try getting your score for “free” from third parties. However, you should read their terms carefully because you may need to enroll in a program with a fee or purchase a product to get the “free” score.