One of the best times to lay a solid financial foundation is when you are in your 20s. This decade of your life sets the stage for your financial success. What you understand about money can help you moving forward. What you know about credit is an essential piece to your long-term financial puzzle. The more you know about credit, the better able you will be to make informed decisions and avoid the pitfalls.
Credit = Borrowing Money
Credit is one way to say that you are borrowing money. When you open a credit card account, it feels like you are being offered money. However, what you are actually offered is the ability to borrow that money. You are expected to repay the amount that you borrow -- with interest. It isn't your money.
Using a credit card isn't the only way to borrow money. Car loans, personal loans, student loans, and payday loans are all forms of credit. Even when you take a mortgage to buy a home you engage in a credit transaction. Realize that when you use credit, you will likely pay an interest cost for borrowing. You will repay more than the original amount you borrowed. The main exception to this rule is credit card borrowing. As long as you pay off the entire balance before interest accrues, you can avoid interest. However, as long as you carry a credit card balance into the next month, you will pay interest.
Your Credit Decisions (and Other Financial Choices) Are Tracked
When you borrow money, your decision is reported to credit bureaus. These bureaus compile information about your loan accounts, including how much you borrow and whether or not you make your payments on time. This record is used to create your credit score. Your credit score is a numeric representation of your reliability in repaying loans.
Even some of your non-credit financial choices are tracked. If you skip rent payments, your landlord can report you to a credit bureau, even though you aren't borrowing. Additionally, there are some authorities that turn delinquent accounts over to collection agencies, and those accounts end up on your credit report. Some libraries turn over unpaid fines, and there are city governments that turn over unpaid parking tickets. All of that can influence how you appear to someone making decisions about your finances.
Your Credit Score Impacts Various Aspects of Your Finances
The biggest way your credit score impacts your finances relates to your ability to borrow. If you have a good score, you are more likely to be approved for a loan, and you can expect to pay a lower interest rate. You can save tens of thousands of dollars in your lifetime just because you have a credit score that qualifies you for the best interest rates. You should know that your credit score can impact non-loan areas of your life. Some states allow insurers to use credit information to set your premiums, and many landlords will charge higher security deposits to those with poor credit. Even getting cell phone or TV service can be difficult and more expensive if you have poor credit. Building good credit habits can save you thousands, even if you aren't borrowing money.
You Have Multiple Credit Scores
Much of the information in your credit report is used to calculate your credit score. However, one thing to know about credit is that you have multiple credit scores. Different credit bureaus and others have slightly different formulas for calculating scores. Additionally, not all information is reported to the same bureaus, and credit bureau scores are based on the information they have. Some lenders use their own versions of scores when evaluating you. On top of that, the score you see when you access your "consumer score" might not be the same score used to make decisions. Keep that in mind as you access free scores offered online. Tracking your score can help you get a rough idea of where you stand and whether you are making good progress, but you won't be able to pinpoint exactly the way lenders and others see you.
Building Good Credit Habits
The best thing to know about credit is how you can start building good credit habits while in your 20s. This is the time to establish a good credit history. You can do so by using credit responsibly. Make all of your payments, including non-loan bills like utilities, on time. Use a credit card to make one or two purchases each month, and then pay the card off immediately. Finally, only borrow what you need to, and try to pay off your loans as quickly as possible. Create a budget and stick with it so that borrowing doesn't become a habit. This will keep you from getting in over your head.