Many of you might have heard the term credit or credit score or FICO score. How do credit or credit scores affect your life? What are the advantages and disadvantages of having a good credit score? Understanding these questions is essential for financial wellness and using credit cards effectively. Credit allows people to purchase goods and services using borrowed money from lending services, such as banks. Credit can be in several things, such as credit cards, student loans, personal loans, or mortgages.
WHAT ARE DIFFERENT TYPES OF CREDIT?
There are a couple of credit options: revolving credit and installment loans. Revolving credit is a credit line that remains available as you pay it off. Credit cards are examples of revolving credit. There is no fixed payment; however, you must pay back how much money you use at the end of the billing cycle. If you carry a balance on your credit card at the end of the month, the lending bank will charge you interest. Paying interest defeats the whole purpose of using a credit card. Installment loans require monthly payments of the same amount for an extended period. An example of installments are auto loans, mortgages, and student loans.
Credit lenders make money from a borrower by applying an interest rate to the money used on credit. The higher the balance on the credit card and the higher the interest rate, the more you are charged in interest. It is crucial to pay your credit card statement balance in full each month to avoid being charged interest. Interest rates are fixed annual percentage rates (APR). If individuals miss credit card payments to lenders, this will decrease their credit score.
WHAT IS A CREDIT SCORE?
Many of you may have heard of the term FICO or FICO score. FICO stands for the Fair Isaac Corporation. FICO is a method used to calculate credit scores based on an individual’s information collected by creditors. Credit score and FICO score are used interchangeably and mean the same thing. FICO score is a tool lending institutions use to determine how risky an individual is when applying for a loan. Credit score estimates your trustworthiness in paying back a loan in the eyes of the lender.
HOW ARE CREDIT SCORES DETERMINED?
Five factors that determine a person’s credit score include their history (35%), the amount owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%).
Each credit factor weighs a different percentage of the total. Three credit bureaus report credit information: Experian, Equifax, and Transunion.
DOES A BETTER CREDIT SCORE MEAN BETTER CREDIT OPTIONS?
According to the credit bureau, the higher the credit score, the lower the Annual Percentage Rate (APR) on credit cards, car loans, home loans, or other credit products. If you need to borrow money, having a high credit score makes you more likely to be approved for a loan and get better terms, like a lower interest rate. Another advantage of a higher credit score is higher borrowing power. Having higher borrowing power is not without the risk of paying higher interest if you carry a balance on a credit card.
HOW DO YOU BUILD A GOOD CREDIT SCORE?
If you do not have any credit history or have bad credit, the best way to build good credit is by getting a secured card through your current bank or any lender you feel comfortable with. What is the difference between a secured versus an unsecured credit card? With a secured credit card,
you must put down collateral as a cash deposit, which sets your credit limit with a financial institution. For example, you give a bank $500, and they provide a secured credit card with a $500 credit limit. An unsecured credit card is revolving credit, and you make your monthly payment. When looking for a secure credit card, you want to make sure of a couple of things: the secure card does not have an annual fee or a monthly maintenance fee, and you can get rewards points or cash back. Another important thing when selecting a secure credit card is making sure the secured credit card can graduate into an unsecured credit card. You want to do your research before applying for any secured credit card. I cannot stress enough the importance of paying your balance in full every month on your secured card as this will prove your creditworthiness with the lending institution.
THE DISADVANTAGES OF USING CREDIT
It can be easy to overuse credit cards, carry a balance, and pay large amounts in interest. The borrower must pay the total credit balance to avoid paying interest and to benefit from credit card use. Late or missed payments will lower your credit score, and using credit too much can result in monthly payments that are not sustainable.
ADVANTAGES OF CREDITS
Advantages include earning a cash-back credit card that gives you a percentage back for purchases. A better credit score will help you get a better interest rate for car, personal, or mortgage loans. It also helps with unauthorized charge protection.
You can take short courses on iGRAD and learn more about your credit score, what credit means, and the types of credit. These free courses are accessible to USM students and staff from beginner to intermediate levels to improve their financial wellness. I have added a QR code to get into the course.
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