Financial Literacy: Understanding Credit
07/02/2025
Financial Literacy: Understanding Credit
Learning the fundamentals of credit is an exceptionally important part of financial literacy. Without truly understanding how to use credit properly to achieve long term financial goals, credit can cause stress and cost you a lot of money. Let’s get the conversation started on what credit is and how it can be useful!
Simply put, credit is when someone borrows money and agrees to pay it back. The money owed is now considered debt. In terms of banking, credit is usually offered to individuals by lenders. You (the borrower) agree to pay back the lender. Most commonly, credit is taken out in the form of credit cards and loans. You can get a variety of loans such as student loans, car loans, home loans, et cetera. However, there is a fee to borrow money from the lender, which is called “interest.” Your total fees plus interest for borrowing money from a lender will be expressed as the Annual Percentage Rate or APR. The lower the APR, the less you will pay over the course of your loan. The lender will also set a repayment schedule.
Integral to the borrowing process is your credit reputation, as seen in your credit report. This report will tell lenders how much credit you are currently using, how well you have repaid past debts, the length of your credit history, and information on your ability to repay a new loan. All this information will be manifested in a credit score between 300 to 850 (maximum scores vary based on credit scoring model), with higher scores indicating better credit risks for lenders. Maintain good credit habits, like timely repayment, to keep your score high.
Now that we understand how credit works, how do you know when you should use credit and how to create healthy credit habits? The answer is a little complicated, and highly individualized. General healthy credit habits include:
- Not applying for credit you do not need,
- Not overspending and taking on extra debt,
- Paying off credit cards as much as possible, and
- Paying bills on time.
Knowing when to use credit, however, is less generalized. Determine when to use credit based on what is important to you. Credit can be a life saver in emergency situations, but it can also get you closer to your long-term goals. Whether this means going to college, owning a vehicle, or purchasing a home, credit can help you achieve these goals.
Taking on debt, especially large debt, is scary and many hesitate to do so. The key is to fully understand the debt you are taking on before you do so. There are many helpful resources online which can help you calculate projected payments and total interest accrued and get education on how to know when a debt may be too much for your current budget. This is very important for those just starting their financial journeys, as taking out credit to which you do not fully understand the long-term implications of can affect your finances for decades to come.
People of all ages, and at all stages of their financial journey, can benefit from fully understanding credit and how it can be beneficial, if used thoughtfully. Through financial literacy, we can help our children, friends, and family better understand financial concepts so they can have a thriving financial life!
Sources:
https://iog.wayne.edu/outreach/2017_understanding_credit_book.pdf
https://finredstage.usalearning.gov/assets/downloads/USCG%20TC%20Handout-Understanding%20Credit.pdf