What Is Credit, Anyway?

mansion

While credit cards often bring to mind excessive spending and lavish lifestyles, like the $200 million mansion shown here, they can also be a practical tool. Photograph by Atwater Village Newbie, courtesy Wikimedia. CC-BY-2.0

Credit cards bring to mind shopping sprees, exotic trips, or buying your dream house. Walking into any store and just swiping away—or, these days, inserting your chip card.

Are we giving credit cards too much credit?

We talked with financial advisor Gustavo Camacho about what credit is and how credit cards can be an important part of establishing financial security.

Credit is a measure of financial dependability. Essentially it’s a score that states how reliable you are in paying back money that a bank or other institution lends you. Camacho explains, “the higher the score, the more financially dependable you are known to be to businesses.” Just like you don’t want to lend money to a friend with a terrible record of paying it back, neither do banks.

To build credit, Camacho notes that “you need to utilize debt accounts such as student loans, credit cards, auto loans, and home loans.” If you don’t have student loans and have not bought a car or a house yet, then credit cards are your best option to start building credit. By using a credit card responsibly (no shopping sprees or crazy vacations) and paying off the balance each month, you begin establishing a “track record of borrowing money and paying it back [which] is vital towards proving how reliable you can be to institutions that lend you money.”

While a credit card does not mean buying your dream house, strong credit history does determine what housing options are available to you. If it seems like buying a house is years and years away … that’s the point. The more years you have to build credit wisely, the better your credit score will be by the time you are ready to buy a house or car.

What about the risk of credit card debt?

As Camacho points out, “a credit card can make it very easy to lose track of expenses.”

Unlike with debit card purchases, when you charge something to your credit card, you don’t see the money leave your account immediately. Instead, you receive a monthly statement of your purchases, which you then have to pay using money in your checking or savings account. If you don’t pay off the balance, the bank can charge interest on the remaining amount. Camacho explains that “as a general rule, if you aren’t able to pay off the balance each month, you are spending too much.” He recommends that everyone “create a budget or use an automated expense tracker like Mint.com to monitor your expenses and see where you might be able to make easy fixes.”

When choosing a credit card, make sure to find one with no annual fee and a low interest rate. Keep an eye out for cards with perks such as cash back or travel points. Another reason to have a credit card is that it in the event of an emergency (if something happened to a family member who lives across the country, for instance) you could charge an expensive last minute flight if you didn’t have the money available right then.

Just like it’s important to start building credit now, it’s also important to start saving early. Camacho stressed that saving early is the single most important part of financial literacy. If you start saving money and building credit now he promises that “your future self will thank you.”

 

More Financial Literacy Resources:

Resources for Youth from MyMoney.gov

High School Financial Planning Program

 

2 responses to “What Is Credit, Anyway?

  1. Pingback: 11 Things We Learned This Week | Nat Geo Education Blog·

  2. Pingback: 11 Things We Learned This Week | Nat Geo Education Blog·

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