There is no doubt about it: Credit can be a confusing and frustrating mess. But what is credit really?
Ask 10 people what credit means to them, and you will likely get 10 different answers. To some people, credit is a trap, a gateway into inescapable debt. To other people, credit is magic and mystery that happens in some ultimate computer in the back of banks. And of course, we have all met the individuals who claim they know all the tricks to using credit, but cannot explain how and why it works. We hear about credit almost every day as this seemingly mysterious force that can lead to riches or ruin. And good luck to you if you try to read through the credit companies endless fine print!
In my quest to understand credit, I found a large amount of confusing information. All I wanted to do, was to figure out which credit rewards card, if any, was the best for me. At first I felt frustrated and lost, but the more I researched, the more I realized that people’s understanding is often unnecessarily complex for what they need. Underneath the maze of contracts and terms, I found a common theme!
CREDIT: WHAT IT MEANS
Credit, at its most basic level, is a reflection of both how RELIABLE you are and how MUCH you have in income. Your credit is essentially how much someone (bank, investor, ect), is willing to bet on you by trusting you with their money. Nearly all factors that banks use to analyze your credit score, fall into categories of reliability and income.
While both of these factors are equally important, you don’t have to have large amounts of income to have good or even excellent credit. Remember, credit is a reflection of how much a financial institution is willing to lend you with the assurance that you will be able to pay it back. Now, obviously it would be easiest if we all had multi-million dollar incomes. Banks would be lining up left and right, offering us credit cards, special bank accounts, and car loans because with that kind of money, they would be assured that we could easily pay them back! However since most of us have limited income, the majority of our focus should be dedicated to reliability.
CREDIT: HOW RELIABLE ARE YOU?
Think about it: How willing are you to lend to someone who borrows $5 dollars every Monday, and pays you back $6 every single Friday. Pretty great deal right? On the other hand, how willing are you to lend money to ask for $8 dollars on Monday, another $10 on Tuesday, $12 dollars on Thursday, and then tells you they can only afford to give you back $6 on Friday, but they will get you more next week! You would likely stop lending that person money after the first week, because in your eyes they are not reliable! They have not given you any confidence that they can pay back what you lend them in a timely manner.
Now you may be asking yourself: “That is great and all, but why do I need credit? I use a monthly budget, and don’t see the point in using a credit card when I can just use cash or a debit card.”
CREDIT: WHY DO I NEED IT?
Thats a great question! There are several answers to this question that we will be answering in this series. However, for now what you SHOULD be asking is, what does my credit affect in my life? Did you know that your credit affects more then just credit cards? It affects the rates you get for car loans, housing loans, rental applications, and even business loans. We will break down the dollars and cents of good credit and show why it pays in the long run in a later article, but for now we will say that great credit saves you hundreds to thousands of dollars in interest. I don’t know about you, but I try to make every dollar count. If I can save a few hundred dollars just by putting some extra effort into paying my bills on time (which I need to do anyway!), I call that win win.
Readers: what are some aspects of credit that you find confusing? What frustrates you the most about credit? Let us know in the comments!