Credit and loans can be helpful tools on your financial journey, but ones that require you to proceed with caution.
A study from WSFS Bank of 2,005 Americans between ages 18-40 found that 78% of respondents said they weren’t good at maintaining good credit.
U.S. consumer debt reached a record of $14.88 trillion in 2020, according to Experian, so it is important to be responsible about the credit and loans you take out.
Here are some tips on how to borrow responsibly to avoid some financial pitfalls that can come with credit.
Good Credit vs. Bad Credit
Building your credit is an important step in achieving your financial goals, but it’s imperative to distinguish between good credit and bad credit. Where possible, you’ll want to try to build a good credit score, usually around 700, before borrowing.
Good credit means you’re making payments on time. Your payment history is typically the largest determining factor in your credit score, so you’ll want to stay current on payments and try to pay off revolving credit accounts such as credit cards in full when possible to avoid accruing interest. Your credit utilization, history, mix, and new lines of credit will also play a role in determining your credit score, so ensure you know how each impacts your score.
Bad credit can make it harder to borrow money in the future and result in higher interest rates. If your credit history isn’t the greatest or you’ve previously missed payments, you’ll want to take steps as soon as possible to improve your credit score, including paying down high interest loans and working on your debt-to-credit ratio.
The Four “Cs” of Credit
Before borrowing, you should ask yourself a few questions, and the four “Cs” of credit are a great place to start.
- Capacity: Are you currently employed, what is your monthly income and how does this compare to your monthly expenses?
- Capital: How much do you have saved in your bank accounts and do you have any other assets or investments?
- Character: Have you had credit and loans in the past, and how many lines of credit do you currently have?
- Collateral: Do you have assets, for example your house, to secure the loan beyond your capacity to pay the loan?
Most importantly, ask yourself if you really need what you’re borrowing money for, and if the answer is yes, calculate the true cost of buying it on credit.
For example, if you purchased a $1,000 computer on your credit card that carries an 18% annual percentage rate (APR) and only made minimum payments of 3.5% each month, it would take six and a half years to pay off the credit and the true cost of the computer would be more than $1,500.
In situations like these, try to pay down as much of the loan or credit card balance as you comfortably can each month to limit the interest accrued.
Monitor Your Credit Closely
It can be easy for items to slip through the cracks when it comes to monitoring accounts, especially if you have multiple lines of credit. Keeping a close eye on your accounts will not only help you avoid interest on missed payments, it can also help protect your personal and financial information.
Unfortunately there are no shortage of scammers out there, some of whom will open credit accounts in the name of consumers whose identity they’ve stolen and run up hefty bills. Negative items can remain on your credit reports for years, so it is important to check your credit reports periodically to ensure no fraudulent or inaccurate items appear. Report and dispute any items that are false or incorrect to your bank and the three major credit agencies (Equifax, Experian and TransUnion) as soon as possible.
Your credit can have an impact on a variety of things, including potential employment and housing, so it’s vital to borrow only for life-improving necessities and try to maintain a solid credit score.
The most important rule when it comes to your finances is to always live within your means. If you feel you need more help in creating a plan to build or improve your credit, there are a variety of online resources available or you can make an appointment to speak with someone from your bank for help.
Helping you boost your financial intelligence.
Read our financial resources from your friends at WSFS.