Credit 101: The Basics of Credit – Why You Need It, How You Get It, How To Keep It Good

It was only one generation ago that people had no choice but to live on cash alone. Credit was a very new concept when my parents were my age. My dad would get his pay and they had to make it last. They tell stories about going to the grocery store with only $6 to spend because payday was still 2 days away. You had to get a pay advance from your employer if you wanted to take a vacation, and never mind buying big ticket items if you didn’t save up for months ahead of time.

It’s amazing how in such a short amount of time, credit has become so readily available and so widely used. My kids will never experience the reality of not being able to afford something, because even if they can’t afford it, they’ll still be able to go out and buy it. They’ll probably have a credit card before they’ve even moved out on their own.

Although having oodles of money available to us at all times is an awesome convenience, it does of course come with a price. This is why some people are staunchly opposed to having credit cards. I know some people who are bravely hanging onto their “no credit” attitudes in an effort to stave off consumer debt. But are they really doing themselves a favor or are they actually doing themselves harm?

creditWHY YOU NEED CREDIT

Today’s world is one of instant gratification; almost anything we desire, from information to products, is virtually at our fingertips. When it comes to consumerism, we’re more impatient than ever, and our money habits have followed suit. According to the U.S. Bureau of Economic Analysis, peoples’ personal savings rate has fallen to only 5.4 percent, from a high of 14.6 percent in 1975. As a result, we need to rely more and more on having credit made available to us for purchasing those bigger ticket items (and some of the small stuff too).

While our parents put money aside for things like vacations and furniture, we now rely on the banks and credit cards in order to buy these things. And of course, that’s in addition to things like mortgages and car loans which we were already counting on borrowing for.

So, when you combine our need to have things instantly with our reduced savings habits, it’s almost inconceivable that we’d be able to get through life without needing credit.

Advantages to using credit cards

Besides having a bonafide need for credit such as mortgages, loans, and lines of credit in this day and age, there are also a number of advantages to using consumer credit cards.

shoppingSign-up bonuses

As our voracious need for credit increases, the competition for our credit business is heating up. As a result, the consumer is in an increasingly advantageous position as far as getting more bang for our buck. Credit card companies are coming up with bigger and better bonuses all the time. Among the lures being used are awesome introductory APR’s (some as low as 0%) and bonus rewards.

Rewards

The Federal Reserve Bank of New York shows the current non-housing debt at just over $3 trillion. As the credit cards vie for their piece of the lucrative debt business, they’re constantly coming out with richer rewards for their loyal customers. You can now earn cash, air travel, cruise travel, groceries, and store gift cards, among many other enticing freebies.

And in most cases, the rewards are added to your account immediately, but the interest may not accrue for several weeks, giving you an opportunity to get paid to use your credit card. Of course, this only works if you pay off the entire balance on your card before any interest accrues at all.

Credit cardsInsurance coverage

Some credit cards have built in insurance coverages on certain purchases, such as travel insurance or car rental insurance. It’s worthwhile to read the small print to avoid accidentally paying extra for a coverage you already have.

Consumer protection

Some cards also offer extensions on manufacturers’ warranties or protection against fraud. Credit cards deal with potential fraud on your account very efficiently and quickly compared to how the banks handle a possible compromise on your debit or bank account.

creditHOW TO GET CREDIT

Although getting credit is getting easier as the competition mounts and more options become available to us, convincing the bank to extend those larger credit vehicles, like mortgages and lines of credit, can still be a challenge. The banks are getting more creative and diversified as far as the number of different credit products they offer, but they’re still wary of taking a risk.

In order to get approved for those larger amounts, you still have to have laid the groundwork by proving that you’re a good credit customer. The only way to do that is to start with smaller credit products and establish a proven pattern of responsibility and reliability for paying them back on time.

Luckily, as already mentioned, the credit card companies are chomping at the bit to have us as customers, so there are literally hundreds of cards to choose from. So where do you start?

creditChoosing a credit card

When comparing all the different credit cards out there, you’ll have lots of criteria to consider. Although interest rate is the obvious selling point, you may also want to consider the following:

Rewards

As I mentioned previously, there are several different types of rewards available, so whether you’re looking for cash, travel, or products, there is a program out there to suit your needs and tastes. Don’t take the reward program at face value though, as each program will have its own restrictions and possible fees associated with it.

Take travel rewards, for instance. You can choose from a generic program, where you can use the points accumulated to purchase any travel product, like flights, hotels, and even car rentals, or you can choose a program that only allows you to redeem points for a specific company, such as a specific cruise line or airline. It’s a worthwhile exercise to review the point redemption rules for the program you’re thinking of going with; sometimes there are additional fees incurred for the privilege of using your points.

Admittedly, travel rewards programs are becoming more flexible and generic though, as companies face more competition and face losing business to the programs with more flexible and affordable redemption options.

Also, keep in mind that generally speaking, the better, more affordable, and more flexible rewards programs are likely to be available at a higher interest rate on the credit card.

Minimum Payment

Each credit card will have its own requirement as to the percentage of the total debt that must be paid each month. Keep this in mind if you intend to carry a balance on the card from month to month. In other words, the card may be tempting because of its lower interest rate, but if you intend to do a balance transfer of a hefty debt from another card, make sure that you can still afford the monthly minimum payments.

credit trapGrace period

Different credit cards start to accrue interest after a varying number of days, and not all cards have a grace period. Some cards start to charge interest from the moment of purchase. It’s a real advantage to be able to pay your balance after 20 or 30 days without accruing interest, so make sure your card’s grace period aligns with your intended use of the card.

Fees

Another area that can differ greatly from one card to another, is the annual fee charged on the account. Fees on credit cards can vary from $0 to hundreds of dollars per year. Generally speaking, the better the reward program and/or interest rate, the higher the annual fee. Also, cards will sometimes charge for additional card holders as well.

Who’s offering the card?

Make sure you’re familiar with the bank or company offering the card and that the card is accepted where you intend to use it. For instance, some cards are not generally accepted by certain big box stores or in some foreign countries.

It can get overwhelming to choose the card that’s right for you, but this online comparison tool is awesome, letting you filter based on several different criteria.

creditHOW TO KEEP YOUR CREDIT RATING GOOD

Once you have your credit in place, whether it’s a credit card, line of credit, loan, or mortgage, it’s important to keep your credit rating healthy. Having poor credit can affect your success in getting more credit from the banks, like mortgages, and can result in higher interest rates on those loans. Also, having bad credit can be a barrier to making large purchases, like a car, or can even affect your ability to rent an apartment.

There are a few ways that you can build up and maintain a good credit rating:

Pay your bills.

Missing a payment will not only put a negative flag on your credit report, but missing a payment on your credit card may result in your interest rate being increased.

Pay your bills on time.

Missing the due date basically looks like you didn’t make a payment at all. Many times a late payment will result in a penalty charge and several late payments could even cause a service (like utilities or phone) to be discontinued. Also, some credit cards will increase your interest rate after a set number of late payments.

Don’t overuse your credit cards.

Having too many credit cards at their maximum contributes to a lower credit score. In fact, using only about 10% to 30% of your available credit at any given time is near the optimal usage in the banks’ eyes.

swipeDon’t co-sign loans for others.

This is usually a lesson that’s learned the hard way. I mean, who doesn’t want to help out a friend or family member if they can? Co-signing for a reliable person seems like a no-risk situation, but your credit rating could take a major hit if someone you co-signed for becomes unavailable to make payments on their loan.

Have at least one credit card.

It may seem like I’m talking in circles now, but the fastest and best way to build up your credit rating is to get a credit card and use it… responsibly. So although some people believe that if you never have a credit card then you can never get a bad credit rating, the opposite is almost true; the only way to prove to the banks that you are a low risk when it comes to borrowing money is to borrow money from them.

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