Basic Facts about Credit

Consumer credit is one of the most vital engines in the modern economy. Used wisely, it significantly enhances an individuals' financial power and flexibility. Purchases such as homes and vehicles typically require the kind of long term financing provided by banks or credit unions.

We have become accustomed to not only "getting a loan"- which is credit- for big purchases, but for everything right down to the daily latte. Credit is offered on purchases at most department stores, mom-and-pop stores, mail-order houses, magazine publishers, and used car lots. Its just sign and go- with your new stuff. Many people think of credit as something earned, perhaps as a reward.

Is all this buy now pay later wise? What really is credit? It's basically a loan.

In accounting terminology, credit and its counterpart, debit, have very narrow definitions. If Company "A" sells a widget to Company "B", then "A" lists the sale as a Credit (a plus to their bank account) and "B" lists the purchase as a Debit (a minus to their bank account). The department store gets the credit. You get the debit.

Credit then becomes the question of how much is the company willing to let you walk away with. The value of the goods they either produced or bought for resale. They decide if you're worth the risk; you decide if you're willing to pay them to take the risk- that's part of the interest that you pay.

Credit worthiness is quite simply a measure of how likely a consumer is to repay debt. Credit issuers depend on several large companies to determine someones repayment history and thus their likely repayment future. Only a few companies conduct their own background checks on potential customers before offering credit.

So you agree to pay for the product, the risk they take, and the cost of their money (more interest).

Buying all this stuff on credit seems easy, but remember, you only have a limited amount of credit available to you. When you factor in the amount you must repay every month on the house, and the car, and the boat, plus the department store card, and the other plastic, how much cash is left? How much more "loan" does the bank think you'll be able to repay? And what if your income goes down?

Think of credit as a tool in your financial arsenal. It's not the easy fix for failing to plan and work a rational budget. And never forget, it's not free. The interest paid on a new car can easily add several thousand dollars to the price. And many people find that they're still trying to pay off the nice dinner they charged three years ago. Use credit thoughtfully, wisely, and sparingly.