Building Credit | Part One: Credit Basics
Updated: Dec 4, 2020
Building a positive credit history is essential to establishing a healthy financial situation. Whether you are new to the concept of building credit or seeking to restore a damaged credit history, our latest four-part series will help you to improve your financial health.
Credit provides consumers with a number of advantages, such as the ability to buy necessary items immediately. Credit serves as a convenient alternative to carrying cash or writing checks, and it can be used to consolidate multiple bills into a single payment. Establishing a good credit history provides consumers with special benefits such as lower interest rates on credit cards and loans, a better chance for future credit approval, higher credit limits, easier approval for rental housing, and more.
Risks and disadvantages also accompany credit usage, and it is up to you to use your credit responsibly. Interest payments and additional fees result in higher costs for items. Poor credit management, such as making late payments or engaging in unchecked impulse buying, can lead to financial difficulty or ruin.
Types of Credit
There are three main types of credit: single-payment credit, installment credit, and revolving credit.
In the context of single-payment credit, a single repayment is made within a given time period after the purchase of an item or service. Interest is not usually charged on these types of purchases. Examples of single-payment credit usage include utility bills and medical expenses that are paid after the date of service.
Installment credit is used to pay for merchandise and services in two or more regularly scheduled payments of a set amount. Interest is paid with each installment.
Installment credit is offered by some retail businesses, such as car and appliance dealers. It can also be utilized in the case of a loan taken out for a specific purpose.
Revolving credit allows consumers to buy many different goods and services, as long as the total amount does not go over their credit limit, an assigned dollar limit assigned to the credit user. Credit users make regular payments for any amount at or above the required minimum balance; interest is charged on the remaining balance. Revolving credit is offered by retail stores and financial institutions that issue credit cards.
Safe Debt Load: Follow the 20-10 Rule
To calculate how much credit you can afford to carry, follow the “20-10 Rule.” You should never borrow more than 20% of your yearly net income, and monthly credit payments should not exceed 10% of your monthly net income. Following these guidelines will keep you from taking on more credit than you can afford to pay.
Note that your net income is the amount of money you’ve earned after taxes.
Housing debt, such as mortgage payments, should not be included in your 20-10 rule calculations, but all other debt should be included, such as:
General Guidelines for Responsible Credit Usage
Borrow only what you can repay.
Read and understand each credit contract.
Pay debts promptly.
Notify your creditor(s) if you are unable to meet a payment.
Report lost or stolen credit cards immediately.
Protect your credit card number from theft.
In the second part of our series on building credit, we will explore the “Three C’s of Creditworthiness.” Stay tuned for more!
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