If you are new to the world of credit, your first question is probably, “What is credit”? Credit is a contract between a buyer and seller stating that the buyer will have the ability to borrow money or access products or services with the promise that they will pay back the money or services at an agreed-upon time. Essentially, it allows you to get what you need now, knowing that you will pay it back later. You can also Learn 4 Ways to Build Credit Quickly here.

Types of Credit

The three types of credit are Revolving, Installment, and Open. Revolving credit lets you borrow up to a certain amount repeatedly. Examples of revolving credit are credit cards and home equity lines of credit.

With installment credit, you borrow money one time and pay it back over an agreed amount of time with interest. Auto loans, mortgages, and personal loans are all types of installment credit.

Open credit is a line of credit that you pay after you use it. Utility bills and phone bills are examples of open credit. This kind of credit does not have interest, but you may be fined and/or have your service removed for not paying the bill by an agreed time.

What is Interest?

Interest is a percentage of the total amount of the loan or usage of a credit card charged to the borrower. With credit, the lower the interest rate, the better for your wallet. Lower interest rates are better because you pay less for borrowing money. Higher interest rates mean you pay more money for borrowing money.

How Do Interest Rates Work?

Interest rates on loans are usually lower than on credit cards, but the amount you borrow and the amount of time you take to pay it off are usually higher than on credit cards. There are several different types of loans, including auto, mortgage, personal, student, home equity, credit-builder, and payday loans.

The interest rate you get with a loan depends on the type of loan and your credit score. For example, payday loan rates are typically very high (~400%), while the federal student loan interest rate is about 4%. One one hand, having collateral for a loan will make it easier to borrow and may lower your interest rate because it makes lending less risky for the lender. But on the other hand, using collateral to get a loan is risky because the lender will be able to take your collateral if you cannot repay the loan. This article from britannica.com goes more in-depth on this topic. 

What If You Have Bad Credit?

If you have no credit or bad credit, it may be difficult to get a credit card or a loan. The lender may think you will misuse the credit you receive, or they may think it is too risky to find out how you will use it.

Having no credit is better than having bad credit because you have a chance to start well. Having a cosigner or collateral can help you get a loan if you have no credit or bad credit. If you use a cosigner, your cosigner will have to make payments on your loan if you do not make payments. A co-signer should be someone you trust and are completely honest with about your financial situation. You should only ask someone to co-sign for you if you know you can pay back the debt without damaging their credit.

How Do Credit Cards Work?

With credit cards, you pay interest on the amount of money left on the card on each month’s due date. So if you always pay back the entire balance on the card on or before the due date, you will not have to pay interest. Interest rates on credit cards are typically higher than on loans because the risk to the lender is higher. The rate you get can depend on the type of credit card you get and your credit score.

Getting a secured credit card can help you build enough credit so that you can open an unsecured credit card. You borrow against the money you give the lender with a secured credit card. You will need to save up some money, typically $300 to $500 minimum. The specific amount will depend on your lender.