Managing credit wisely is among the most important lessons for anyone to learn.  Credit is access to money that must be paid back at a later time with interest.  There are two main parties involved in the extension of credit - borrowers and lenders.  Borrowers are those people or companies who use another's money with a promise to repay that amount plus interest out of future income.  Lenders are those who extend credit to the borrowers.

Credit allows people to enjoy things now and pay for them later.  It is often used for emergencies or as a convenience for regular expenditures.  If used properly, credit can be an appropriate way to manage some aspects of an individual's finances.  Credit costs money, however, and often tempts people into overspending.  Consumers spend 1/3 less when paying with cash.  When people overspend, it becomes increasingly difficult for them to save and invest.  It is therefore important to understand how credit works and how to manage it effectively.

Credit cards are not free money.  Too many adults - and students - have wallets filled with credit cards, some of which may be "maxed out" (meaning charged to the limit of allowable funds).  It is important to answer the following questions before making purchases on credit:

Do I really need this item?

Exactly why do I want this item?

Can I afford this item?

How will purchasing this item bring me closer to my financial goals?

What will happen if I can't repay this loan?

A liberal rule of thumb is to limit consumer debt payments to 20 percent of a household's monthly take-home pay.  Consumer debt generally includes installment loans, such as furniture or auto payments, personal loans, credit card balances, and medical debt.  Some households, particularly students and part-time workers, feel overburdened if their debt payments equal 20 percent of take-home pay.  Therefore, they should not reach the maximum amount.

Before applying for credit it is important to understand the terms used in credit applications.

• Annual Percentage Rate (APR) the yearly interest rate charged for the use of credit

• Cash Advance cash received from a credit line.  The cash advance rate is usually higher than the APR.

• Minimum Monthly Payment the smallest amount of money accepted by the creditor each billing cycle to keep an account in good standing

• Grace Period time in which no interest is charged and no late payments are assessed.  Usually a grace period is forfeited if the balance is not paid in full and on time each month.

• Credit Limit the maximum amount of credit allowed on an individual credit account

• Miscellaneous Fees the additional fees a borrower is charged for use of credit, such as late fees, annual fees, over-the-limit fees, and bounced check fees

Credit allows for the use of products and services in exchange for a promise to pay in the future.  The advantages of using credit include:

Immediate use of the product

Convenient and safe

Can be used for emergencies

Provides a method of record keeping

Establishes a credit record

Disadvantages of using credit include:

We spend more money when using credit.

Using credit ties up our future income.

Credit costs money in the form of interest.

Types of Credit

LOAN - usually from banks and financial institutions

CREDIT - regular or revolving

Regular - has an annual fee; pay the full balance at the end of each month

Revolving - make at least a minimum payment; interest is charged on the remaining balance; credit limit (the most you can owe at one time) is established

INSTALLMENT CREDIT - debt repaid in payments; usually for an expensive purchase like a car

Sources of Credit

Banks

Credit Unions

Finance Companies

Savings & Loans

Pawn Shops

Loan Sharks - Illegal

Obtaining Credit

Credit is a loan.

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