Home / Articles / ABCs of Credit: What is Credit?

Weekly Tips

ABCs of Credit: What is Credit?

Nothing down, 24 monthly payments! Low, low 2.9% APR! We may not hear those words as much as we did in the past; however, we still live in world where we are constantly urged to buy things using credit.

But what is credit, and how does it really work? Simply stated, credit allows you to buy something now and pay for it later. Rather than paying at the time of purchase, you simply borrow the money from a creditor and pay for it over time.

In addition, credit not only refers to money that is loaned, but also to the ability of a company or individual to borrow money. Each of us should think of our credit score as our own personal financial reputation.

So, let’s define the two main types of consumer credit transactions: open-end and closed-end.

1. Open-end Credit

An open-end account allows you to make repeated purchases or withdraw money. The balance may be paid in full or in installments. For example, if you purchase a flat screen TV with a credit card and plan to make payments, that purchase is part of an open-end credit plan.

The number of payments is not preset to pay off the TV’s balance, and you can use the same card next week to buy the leather couch to go with it. Some examples of open-end accounts are gas cards, credit cards such as Mastercard and Visa, revolving charge accounts, and checking overdraft protection. Credit issuers have no limit on the interest rate that they may charge for open-end credit.

2. Closed-end Credit

Closed-end credit is credit extended for a set time period and specific amount. For example, if you purchase the same flat screen TV we talked about earlier under a closed-end agreement, you would need to pay a specific payment for a set number of months. Some examples of closed end credit are auto loans, mortgages, personal loans, or a small business loan. These loans are often leveraged to build wealth.

It’s important to remember that credit is more than a plastic card for buying things. A previously mentioned, it’s your financial reputation as well. Guard it like you would your own personal reputation by making informed and ethical choices.

Good credit means that your history of employment, salary and on-time payments also makes you an excellent candidate for a loan. Therefore, your good credit usually translates into lower interest rates, better terms, and more ease in borrowing.

On the other hand, bad Credit will generally make life more expensive and difficult. It results from making payments late or borrowing too much money, and it means you’re going to have trouble getting a car loan, the best credit card, a place to live, or possibly even your next job.

If you’re new to the whole credit world, don’t be afraid of what it has to offer you. Like anything, there are pitfalls, but credit can be a useful partner as you seek to establish long-term financial stability and wealth.

Make time to learn as much as you can about it, and always remember - those who understand credit receive income from it, while those who don’t, pay it.

on Sun, 2009-05-03 17:00