What is Credit?
Credit is a purchase. Shop wisely!
You buy credit just like food or furniture, so it’s important to shop around for the best value! Find out what the credit costs, what you get for your money, and compare the different agreements. Features and costs to check include:
Annual percentage rate (APR): The annual interest rate that is charged on your unpaid balance. Some credit cards have set rates while the APR changes on cards with variable rates. Beware of short-term “teaser” rates printed on the front of promotional offers. Generally speaking, if you don’t expect to pay off your card balance most months, look for a card with a low interest rate and the right mix of rebates or rewards to justify any fees. The APR is far less important if you expect to pay your credit card bill in full each month.
Grace period: The number of days (usually 20-25) that you have before a credit card company starts charging interest on your new purchases. In most cases, an interest-free grace period applies only if you have paid your previous month’s bill in full.
Fees: These may include an annual fee (from $0-$200) that you are charged for the right to use a credit card, transaction fees for cash advances, late payment fees, and fees for going over your credit limit.
Credit limit: The maximum unpaid balance that you can carry in your account. Is it large enough to meet your needs? OR, is too high and a temptation?
Method of calculating finance charges: The most common and advantageous method is the ‘average daily balance’ method where companies add the new purchases to any old debt after the end of the grace period, and then divide by the number of days in the billing cycle to compute the balance on which you pay interest. Some cards have much costlier calculation methods.
Types of credit
- Installment loan - These loans are set for a fixed amount and must be paid over set period of time using a fixed monthly amount. Examples: car loans, personal loans and mortgages.
- Revolving credit - This allows you to borrow up to a set amount called a credit limit. As payments are made and more purchases are made, the balance will revolve, with old debt being replaced by new. Credit cards are the most common revolving credit.
- Service credit - This type of credit allows you to receive a service before you pay. You pay the amount of service you use monthly (and in some situations, quarterly). Examples: utility bills and medical bills.
- Non traditional credit - Typically this type of credit doesn’t show up on your credit report. More and more credits are looking into this type of credit or asking you for letter of reference from these sources. Example: renting.
Equity Lines - Combines features of mortgage and revolving credit. It allows you to secure a loan using the equity of your home and use it as revolving credit. Usually the interest rate is low and can be tax–deductible. A major disadvantage of equity lines is the risk of losing your home if you are unable to pay the loan.