Although taking out a loan may not be on your mind right now, it’s never too early to begin learning how credit (borrowing) works.
Credit is a tool to buy something now and pay for it later. There are good and bad ways to use credit. There are times in life when borrowing is a good idea and there are times when it’s not.
Borrowing almost always involves a cost called “interest,” which is what the bank/credit card company charges you to use their money. This is the reverse of what happens when the bank pays you interest to put your money in the bank.
When you borrow money you are promising to repay the loan on a schedule. Not adhering to that schedule will have consequences. You may have to pay late fees. Worse, you can damage your credit score, which means that you could have a tough time borrowing money in the future.
The most important thing to remember is the longer you take to pay back what you owe on a credit card or loan, the more you’ll pay the lender in interest charges.
If you’re not 18 yet, practice borrowing money by borrowing from your parents and have them set up repayment terms. They may even charge you interest. This is a perfect way to practice for the first loan or credit card you take out.
Once you turn 18, you can open a credit card to start earning credit. Establishing a good reputation of paying your bills in full and on time will help you in the long run when you want to take out a car loan or buy a house etc. But it is imperative to remember when you do get your first credit card to use it responsibly.
Understanding Interest Rates
Fixed Interest Rates stay the same for the life of the loan or account meaning the monthly payment will stay the same throughout the life of the loan
Adjustable or variable interest rates change at specified times, such as every month or year. This means that your monthly payments will change too.
The Rules of Responsible Credit Card Use
- Golden Rule: Charge only what you can afford to pay each month and actually pay it off each month.
This is the ideal way to use your credit card in a responsible manner. By doing so, you’ll build a positive credit history and never pay a dime in interest. Treat the credit card like a debit card and deduct each charge from your bank account balance as if you made the purchase.
This will keep you from spending more than you have in the bank. Resist the urge to pull out the credit card and swipe it because you want to buy something but “don’t have the money right now.”
- Always make your payments on time. Even if you find yourself in a situation where you can’t pay the whole balance, make sure you pay as much as you can (at least the minimum payment) and do so before the due date. Paying on time every month will help you build a good credit score over time. If you find it easier to manage, you can even make more than one payment a month. Set up a payment every other week using your online banking and bill pay if you’d like.
- Plan your purchases. If you are going to use your credit card to finance a big purchase make sure you have a repayment plan that spans a short period of time. Remember the longer it takes you to pay it off, the more you will pay in interest.
- Don’t be tempted by a credit limit increase. The longer you have the card and pay the bill responsibly, the higher your credit limit will become. Just because you CAN spend more money doesn’t mean you SHOULD. Continue to spend only what you can afford to pay off right away.
- Don’t obtain more credit than you need. Opening multiple cards in a short period of time can have a negative effect on your credit. Only open the credit cards you need and don’t be tempted by all the offers that come in the mail.