Understanding credit and when to use it

Understanding when and how to use credit is crucial for building a strong financial foundation. In this blog, we’ll explore the different types of credit available, the benefits and risks of using credit, and how to use it responsibly. 

Whether you’re considering applying for a credit card or learning (or teaching your child) about financial responsibility, this guide should help you make informed credit decisions. With that in mind, let’s dive in and sort out the complexities of credit together!

What are the different types of credit?

Credit comes in various forms, and it’s important to understand how they work and the financial needs associated with each of them.

• Revolving credit: This includes credit cards and lines of credit, where you can borrow up to a certain limit and repay monthly with no set payoff date. The balance can be carried over month-to-month, with interest charged on the outstanding amount. A minimum payment is required each month.
• Installment credit: This includes loans like mortgages, car loans, and student loans. You borrow a fixed amount and repay it in regular installments over a set period. These types of credit have amortization schedules, which determine how much of each payment goes toward principal and interest each month.
• Open credit: This includes accounts like utility bills, where you borrow up to a limit and must repay the full amount each month.

When is it beneficial to use credit?

Using credit can be advantageous in several situations:

• Building credit history: Responsible use of credit helps build a credit history, which is essential for future financial opportunities like loans and mortgages. Without an established credit history, credit bureaus can’t communicate to creditors whether you’re a person who is worthy of offering credit.
• Fraud protection: Credit cards offer better protection against fraud compared to cash. If your card is lost or stolen, you can report it and limit your liability. Many card issuers offer zero-liability fraud protection too, meaning you won't be held responsible for fraudulent purchases if you report them promptly. At UBT, our Card Suite Lite app puts control over your card usage and spending right at your fingertips.
• Rewards and benefits: Many credit cards offer rewards, cash back, and other benefits for purchases, which can add value to your spending.

What are the risks of using credit?

While credit has its benefits, it also comes with associated risks:

• High-interest debt: If you don’t pay off your balance in full each month, interest charged on the remaining balance can accumulate quickly, leading to high debt and future difficulty in paying it off.
• Temptation to overspend: Credit cards can make it easy to overspend, leading to financial strain and debt.
• Impact on credit score: Missed payments and high balances on credit accounts can negatively affect your credit score, making it harder to obtain future credit.

How can you use credit responsibly?

Using credit responsibly involves several key practices:

• Understand terms and fees: Familiarize yourself with your credit card’s terms, fees, and interest rates to avoid unexpected charges.
• Make timely payments: Always pay your credit card bill on time to avoid late fees and interest charges. This timely payment habit will help you establish good credit too!
• Keep balances low: Try to keep your credit card balances low relative to your credit limit to maintain a healthy credit score.
• Monitor your accounts: Regularly check both your credit card and other credit account statements and credit reports for any discrepancies or issues.

What should be considered before a credit account?

Before applying for credit, consider all of the following.

• Credit history: Check in on your credit report regularly to see where your score stands — and to identify any areas where you can improve your creditworthiness. Annualcreditreport.com is a great tool for getting a free credit report once a year, which is also a great time to review your credit history and make sure it’s accurate and error-free.
• Type of credit: Determine which type of credit best suits your needs, whether it’s a credit card, personal loan, or another form of credit. A good rule of thumb is to determine how much interest you’ll be required to pay on the balance for each option — and choose the one that requires less interest paid, naturally.
• Interest rates and fees: Compare different credit options to find the best interest rates and fees that fit your financial situation.
• Repayment ability: Ensure you can afford the monthly payments and manage the debt responsibly to avoid financial strain. Make sure the payments can be worked into your monthly budget and that it’s not causing financial issues if the payment is added to your financial obligations.

Understanding the different types of credit and knowing when to use each of them can help you make informed financial decisions. By using credit responsibly and considering the factors before applying, you can build a strong financial foundation and avoid the pitfalls of debt.