Credit & Debt

What is Credit?

Credit is the ability to borrow money.

Lenders, also called creditors, are willing to lend because they expect to get their money back and make a profit. Different types of lenders – such as banks, investment companies, credit unions, and even the federal government – provide different types of credit.

You’re the borrower. You qualify for credit if lenders consider you creditworthy. That means lending to you isn’t too risky. When you borrow, you promise to repay the amount of money you use within a certain period of time, plus a fee for using the money. If you don’t meet your legal obligation to repay what you owe on time, you’ll pay penalties and face other problems.


The Impact of a Credit Score

Your FICO score does more than let potential lenders decide whether you’re a good or bad credit risk. Based on your score, creditors also determine your interest rate, which impacts your borrowing costs

FICO Score Components

While there are other credit scoring systems, FICO® is the most widely used measure of creditworthiness in the United States.

Your FICO score, which ranges from 300 to 850, is calculated using the information in your credit report. Although the formula is complex, there are five main components:

  1. Your credit payment history which shows how you’ve repaid what you borrowed
  2. The total amount of debt you currently have
  3. The length of your credit history
  4. The different types of credit you use
  5. The new credit you hope to have extended to you

When you use credit wisely, you improve your FICO score. If you exhibit poor repayment behaviors, you’re putting your score at risk.




Why Use Credit?

Credit makes it convenient to buy practically anything you need or want without having the money in your pocket or in the bank. You can:

  • Pay for major expenses like college tuition or a new car
  • Finance unplanned expenses like repairing your car or replacing a damaged laptop
  • Buy the things you need now, like books for your courses or a winter coat
  • Make purchases online or over the phone

The Cost of Credit 

For both revolving and installment credit, the cost of borrowing depends on the same factors:

  • How much you’ve borrowed, called the balance or principal
  • The annual percentage rate (APR) the lender uses to figure the finance charge
  • How long it takes you to repay, sometimes called the term

Develop Smart Spending Habits

Often, you can get your debt under control by developing smart spending habits and making better choices with your money. Try taking the following steps:

  • Avoid impulsive spending, and stick to buying only the things you need
  • When you can, use cash instead of a credit card
  • Limit the number of credit cards you use
  • Pay your credit card bill on time and in full each month instead of wasting your money on interest payments

There are times when simply adjusting your spending habits might not solve the problem. If you’re in serious debt, you might find that your financial situation requires an even bigger change.

With a credit card, the finance charge includes only interest. But with a loan, it also includes other costs, like application fees and checks on your creditworthiness.


Warning Signs

The convenience of credit can make it easy to fall into debt. But if you’re able to recognize the warning signs, you may be able to avoid a serious problem and get your finances back on track. Watch out for these red flags:

  • You pay only the minimum due on your credit cards
  • You skip some card or loan payments
  • You’re maxed out on your credit limit
  • You don’t know how much you owe
  • Your lender lowers your credit limit

If one or more of these situations rings a bell, it’s time to get a handle on your debt.

Types of Credit

Most people use two primary types of credit: credit cards and loans.

  • Credit cards are a type of revolving credit. That means you can use your credit card over and over, as long as you spend less than the credit limit your lender sets and you pay your bills regularly. As you repay what you’ve borrowed, you can borrow that amount again.
  • Loans are installment credit. You borrow a fixed amount and make regular repayments, usually once a month, until you’ve paid off the loan. If you need to borrow more, you try to arrange another loan.

Credit with a Card

A credit card can be a handy way to borrow if you choose the right card and are smart about using it. Using credit this way doesn’t have to cost you a cent — provided the card has a grace period and you always pay the full amount you owe on time.

A grace period is the minimum of 21 days you have to pay your bill after the lender sends it to you. If you pay the whole thing in full by the day it’s due, there’s no finance charge.

But if there’s no grace period or if you pay only part of what you owe, using this type of credit will cost you money—potentially, big money. To figure your finance charge for the month, the lender multiplies 1/12th of your APR times your unpaid balance. That’s the interest you owe.

Avoidable Credit Card Fees and Charges

In addition to interest, there are avoidable credit card fees and charges that can add to your total cost of borrowing. Here are some to look out for—and to avoid.

  • Annual fee: The cost you pay each year to use a card. Annual fees are usually charged on cards that offer special perks and extras, like cash back or miles. The cost of the fees often outweighs the benefits.
  • Late payment fee: The amount you pay if you don’t pay the minimum balance on time.
  • Over limit fee: The amount you pay if you charge more than your credit limit.
  • Cash advance fee: The amount you pay for using your card to borrow cash using an ATM. Interest is charged from the moment you get the cash—and it’s charged at a higher APR.



There are times when a credit card isn’t the best kind of credit to use. For example, if you want to buy something that costs more than you have available on your credit line or that you can’t possibly pay off in a year or two, you can apply for a loan.

For example, you can use a loan to:

  • Buy a car
  • Pay your college tuition
  • Buy a home
  • Start your own business

Some loans, such as car and home loans, are secured, which means if you don’t repay, the lender can repossess what you bought. Unsecured loans, including student loans, are backed only by your promise to pay what you owe. But repayment isn’t an option. It’s required.

Building a Credit History

Anytime you use credit, you’re adding a chapter to your credit history. All your credit transactions are recorded in a credit report, which is available to potential lenders who want to know how you’ve used credit in the past.

Your credit history includes all uses of credit—from student loans to everyday credit purchases—but not other payments, like the ones you make to the utility company or your landlord.

You’re assigned a credit score based on the details of your credit report. Your credit score is a snapshot of your creditworthiness, which lenders use to decide if you present a credit risk. The higher your credit score, the more creditworthy you are, and the more likely you are to receive credit.


Checking Your Credit Report

Protect yourself and your finances against identity theft. Below are some basic steps you can take. The Federal Trade Commission provides helpful tips for keeping your personal information secure.

Check your Credit Regularly

You have access to one free credit report each year from each of the three consumer credit reporting bureaus. You’ll want to monitor your credit report to ensure that no activity occurs on you account that you didn’t initiate.

The 3 Consumer Credit Reporting Bureaus:




Pro Tip: Set an appointment on your calendar at four month intervals to retrieve a credit report from the three credit reporting bureaus. This is the best way to track your credit history and know that your identity is safe.

Protect Your Personal Information

Identity thieves can use your personal identifying information to open accounts, apply for loans, apply for jobs, or commit crimes. Carefully guard your social security number, date of birth, address, bank account numbers, and your student ID number. Shred mail that contains any of these. Be conscious of where you are when you give your social security number over the phone. If others can overhear you, they can steal your information! It is also a good idea to review the personal information that you’ve included on your social media accounts.

Pro Tip: Be careful of entering your information online – only do so if you trust the site (look for the “https“). The “s” means “secure”.

Opening a New Line of Credit?

If you are thinking about applying for a credit card, make sure you understand the terms and conditions. Consult with a parent or someone you trust when you’re making the decision. Here are some questions to ask yourself:

  • Do I really need this? Remember credit is borrowing and you will have to pay it back and then some. Are there other ways to get your needs met without taking on more debt?
  • What is the interest rate? Is there a promotional rate? What will the rate become after the promotion ends?
  • Is the rate fixed or variable?
  • Is there and annual fee for the card?
  • What kinds of perks do you get? (Examples might include airline miles or cash back on certain purchases.)
  • Remember: if you plan for purchases and save money rather than buy on credit, you pay ZERO interest!

Understanding Interest

Fixed Vs. Variable Interest

Interest rates can be “fixed” or “variable.” A fixed interest rate remains the same for the entire lifetime of your loan. Variable interest rates can shift (typically annually) based on market factors.

Simple Vs. Compound Interest

Some accounts pay simple interest, which only accumulates on the principal balance you deposited—not on any accrued interest that has previously capitalized. You’ll still earn money with simple interest, but it will take longer to earn the same amount as you would with compound interest.