But I don’t have the money: credit basics

WHAT IS CREDIT:

So what is credit?

• Credit = Money loaned + interest + fees

It is that simple. Credit is the use of someone else’s money. No more, no less. OK, so there are a few strings attached. Aren’t there always in this game called life? Not only to you have to promise to give it back, but, often times the person (lender) giving it to you will expect you to pay a fee (interest) on the money that you borrow.

COST OF CREDIT:

Now this is where it gets fun. There are so many different types of fees associated with various loans that it really is important to read the fine print before signing your life away. Lenders can charge for simply giving you a loan. This is known as an “origination” fee. Additionally, you will be charged a daily fee (interest rate) for the use of the funds. And don’t be late making your payment or you can expect to see a “late” fee added to your balance. Some loan contracts will even charge you a fee if you pay off your debt before it is due. This is known as a “Pre-payment” penalty. These are just some of the fees that can be charged when borrowing money. Yikes!  No worries though, with a bit of information you will easily discover if the purchase you want is worth borrowing for.

The good news is that all lenders are required by law to disclose the cost of the money to you before you sign on the dotted line. These disclosures discuss what your finance charge (interest & fees) and APR will be.

LEARNING THE LINGO:

APR??? What does April have to do with it? Ok, we all have heard the term APR (Annual Percentage Rate) bantered back and forth. The confusing part for most of us is that very rarely is the APR and interest rate you pay the same. WAIT just a minute you yell! What do you mean they aren’t the same? Hold on and I’ll explain. The interest rate is what you will be charged for using the money over time and the fees are a one time charge. So in order to find out what the “true cost” of the money you are borrowing is, you must add the two together and then divide it out over the length that you will have the cash. This “true” cost is called the APR.  Math! Yuck! Don’t worry, these calculations are done for you so all you need to know is how to make the decision on whether or not the item you want to buy is worth it.

Finance Charge and APR are only two of the credit terms you should know in order to understand credit. Here are a few more terms you should be aware of:

• Introductory Rate — a low APR that increases to a higher rate after a certain period of time.
• Grace Period — the time that new purchases are interest free.
• Delinquency — failure to make your payments on time and/or in the proper amount.
• Minimum Payment — the smallest amount your creditor will accept each month.
• Credit Limit — the maximum amount of money available for your use.
• Due Date — the latest date you can pay your bill without getting charged a late fee.
• Fixed Rate — an interest rate that doesn’t change over time.
• Varialbe Rate – an interest rate that changes at a specific time (monthly, yearly) based on a given index.
• Index — a statistical composite that measures changes in the economy of financial markets.

Now that you know the lingo lets talk about the two basic forms that credit comes in; revolving and installment.

TYPES OF CREDIT:

Installment credit is where you promise to pay back a specific amount, plus finance charges, over a set period of time, usually in equal monthly installments. Once you pay off this loan the account is closed and can no longer be used. Examples of installment loans are auto loans, mortgages, and student loans… you get the picture.

Revolving credit, aka open-end credit, allows you to use the account (provided you still have money left in it) over, and over, and over. These accounts have a pre-set loan limit that you will be authorized to use and as long as you stay within that limit you will not incur an “over the limit” fee. Yes, another potential fee. Credit cards are the most common example of open ended loans.

Just because you might have gotten into trouble with credit before doesn’t mean you should give up on all credit entirely. Not all use of credit is bad. As we said before, credit can be a very useful tool.

For example, a mortgage allows you to buy a home that will likely go up in value, and the interest on the loan is tax deductible. Student loans can be an investment in your future, and can result in substantial extra income over your working life. A small business loan might enable you to start a business and become totally self-sufficient. And a loan to pay for medical care could prevent severe and expensive health problems later on. This is called leveraging your credit. You borrow money to invest in your future. 

The trick is using credit wisely, and making good choices. How? Shop around. Yes, like anything, competition is fierce when it comes to lending money. So look for the best deal and READ the fine print. A low APR might not be such a great deal if the interest rate skyrockets after the initial introductory period. If you pay off your card in full every month then look for a credit card that doesn’t charge you an annual fee.

SHOP AROUND:

Credit, just like any other product or service, usually has a cost associated with it, and you should comparison shop to get the best deal. Before you accept a credit card offer, be sure to read the fine print. If you carry a balance each month, compare the APR and fees to get the best deal. But beware of low introductory rates that can skyrocket after a few months. If you pay your balance in full every month, make sure you get a card with no annual fee. Does the card give you any additional benefits? Travel points? Cash back? A grace period? Is the interest compounded daily, monthly, yearly? What other kinds of fees are there. Cash advance fees? What is there collection policy should you get sick or become unemployed. Will they break your legs? Send “Tony” over to motivate you to pay (just seeing if you are still awake)? These are the types of questions you should have answered before you make your decision on who to borrow from.

When making a decision about credit cards it can be helpful to make a checklist to see how different cards compare. I have included a link to a sample Credit Card Comparison Checklist so you can download your own copy, and use it to compare the terms of your existing credit cards, and any new credit cards you might want to apply for.

 Credit Comparison

REMEMBER THE BASICS:

Wow! That’s a lot of information so I’m going to break it down into a few quick bullet points. Here goes.

• Credit is the temporary use of someone else’s money with the promise that you’ll pay it back in the future, usually with interest and fees.
• The finance charge is everything the loan costs you over and above the amount you borrowed.
• The APR is the true interest rate of the loan after finance charges are taken into account.
• Lenders are required by law to disclose the finance charges and the APR before you take out the loan.
• You can use the APR to compare offers from different lenders.
• Installment loans are for a fixed amount and time. You pay them off in monthly installments.
• Revolving accounts allow you to borrow up to a set limit over and over, but you don’t have to pay it all off within a fixed time.
• And finally it is vital you shop around and read the fine print before signing a contract or credit card agreement.