Understanding debt, and how or when to use it, is one of the biggest challenges for consumers. As you build your personal financial strategy, it is wise to educate yourself on borrowing basics and common credit pitfalls.
Understanding credit cards and credit scores is essential to establishing credit and using credit cards wisely. Your ability to get a loan for larger purchases (houses or cars) generally depends on your credit score, which is made up of different factors that show lenders your track record with debt. Remember, you pay interest on borrowed, or credited funds. The longer you take to pay back the money you borrowed, the more interest you will pay to your lender.
To Borrow or Not To Borrow
The first thing you should determine is whether or not your budget supports your ability to pay your credit card bill in full and on-time. If not, establish a budget and control your spending before opening any lines of credit. Keep the following tips from the National Consumer Law Center in mind to avoid credit card problems:
- Do not use credit cards to finance an unaffordable lifestyle.
- If you get into financial trouble, try to avoid making it worse by using credit cards to make ends meet.
- Don’t get hooked on minimum payments.
- Don’t run up the balance in reliance on temporary “teaser” interest rates.
- Make your credit card payments on time.
- Beware of unsolicited increases by a credit card lender to your credit card limit.
- Don’t max out.
Picking a Card
Debit Cards vs. Credit Cards – A debit card is linked directly to your checking account, and it requires available funds to make purchases. A credit card is linked to a line of credit, which a lender has extended to you. Using credit cards build a credit history, while using debit cards does not.
General vs. Private – General purpose credit cards can be used anywhere, while private label retail cards can generally only be used at the retailer that issued them.
Secured vs. Unsecured – Most general use credit cards are unsecured. This means that the issuer extended you a line of credit based on your credit history, with nothing used as collateral in the event that you stop making payments. Conversely, secured cards are backed by funds you deposit in an account that the lender can claim if you default. Secured cards can help you establish credit if your activity is being reported to credit bureaus.
Understand Your Interest Rate – Interest rates on credit cards vary dramatically. To set your Annual Percentage Rate (APR), creditors can look at your credit score, income, assets, debt load, inquiries, and payment history. Consumers with a positive history in these categories are more likely to receive lower interest rates.
Establishing Credit and Score
As creditors determine the risk associated with lending to you, they will reference your credit score. The FICO score is a commonly used number, and is made up of five categories:
- Amounts Owed – 30%
- Payment History – 35%
- Length of Credit History – 15%
- New Credit – 10%
- Credit Mix – 10%
According to myFICO.com, the minimum requirements for a FICO score are that a credit report must have:
- At least one account opened for six months or more,
- At least one account that has been reported to the credit bureau within the past six months, and
- No indication of deceased on the credit report (If you share an account with another person this may affect you if the other account holder is reported deceased.)
For more information on scores, go to the Federal Trade Commission Credit and Loans site.
Check Your Reports
You are entitled to a free copy of your credit report every 12 months from each of the three nationwide credit bureaus – TransUnion, Equifax, and Experian. Go to Annual Credit Report to get your report. Beware of impostor sites.
Understanding Student Loans
Borrowing to finance education is a hot topic. While you are in college, understand that you are investing in yourself and increasing your future earning power. If you borrow to finance your education, be aware of how much you are borrowing and well-versed in the details of your loans and repayment options. The Office of Financial Aid and Scholarship Programs is your resource for any and all student loan questions.
Hints and Tips
- Your financial aid counselor is happy to answer your questions and provide guidance. Make sure you take advantage of this resource.
- Every year the Financial Aid Office sends a letter to students noting cumulative debt load and estimated payment rates. Use this information along with your budget to determine your future borrowing needs.
- Always look for outside scholarship opportunities. For more info, join the Scholarship listserv.
- If you have graduated and are having trouble making student loan payments, you may be able to reduce your monthly payment amount. Talk to your servicer to discuss your options.
- Consider working part-time instead of taking a refund from your student loan.
Student Loan Resources
- Federal Student Aid – Familiarize yourself with the types of student loans you have, how they work, and repayment plans.
- Repayment Estimator – The student loan repayment estimator. Remember to always work with your servicer on specific repayment amounts and plans.
- National Student Loan Data System – Access your loan history.