Intro to Credit

Remember when you were younger, how fascinated you were whenever you saw someone using a credit card. Back then, it seemed like credit cards were magical squares of plastic that could easily and conveniently be substituted for cash. If you haven’t figured it out yet, here’s one fact about credit that you must know: it’s not a cash substitute, but rather a loan that you must pay back with your future income.

What is Credit?
Whenever you make a purchase today with the promise to pay for it tomorrow, you are using credit. Having credit lets you make purchases when you don’t have cash available. Before a lender will allow you to use credit, it must first believe that you can be trusted to repay the amount of credit you use. This is considered financial trustworthiness.

Lenders use a number of factors to determine your financial trustworthiness. The most commonly used factor is your credit history. How you have used credit in the past – your credit history – is considered to be the best way to predict how you will use it in the future. Your credit history is reported in your credit report and credit score. When you are a new creditor and do not have a credit history, the lender might use other factors such as employment and salary to gauge your financial trustworthiness. Or, the lender might require that someone who does have favorable credit agree to repay your charges if you fail to do so. In this case, the two of you share credit.

How Does It Work?
To establish credit with a financial institution, you must first make an application. The lender will use identifying information, like your social security number, to look up your credit history. If the lender determines that you are a trustworthy borrower, then it will extend credit to you. Once you have been approved for credit, the lender will give you guidelines, or terms, for using your credit. The terms include, but are not limited to, how often you should send payments for purchases, what happens if you are late on a payment, and the cost of using credit.

Usually, the lender establishes a maximum amount of credit that you can use, a credit limit, based on your credit history. Your credit terms will outline what happens if you exceed this limit. In most cases, there is a monetary penalty.

When you’ve been approved for credit, the lender provides you with a way to use this credit, e.g. a credit card. Periodically you will receive a billing statement from your lender detailing purchases you’ve made, interest charged, minimum payment amount due, and payment due date. Per your agreement with the lender, you must make payments by the due date to avoid penalties.