Credit Basics for First-time Users
Important facts on becoming a smart credit consumer
Why is learning about credit important?
Chances are good that most of us will use credit throughout our lives. That’s why it’s so important to learn as much about credit as you can now. What can credit do for you? Everything from providing a financial cushion in case of emergency to improving your chances of buying a house. Developing smart spending habits now will help you avoid the mistakes that can lead to long-term financial problems.
How does a credit card work?
When you use a credit card, you are essentially borrowing money to buy something now that you will pay for later. At the end of the month, you receive a statement that shows your purchases, the total amount you owe and the minimum amount you must pay. If you pay the entire amount due, you won’t pay any interest. However, if you only make the minimum payment, an interest charge will be applied to the remaining balance on your account.
Reasons to use credit
Credit can be a very useful tool in managing your everyday finances, providing a flexible payment option that can make your financial life easier. Responsible use of credit cards is also an important step toward establishing a good credit history, which will give you financial advantages now and in the future. Good credit history leads to a positive credit score, which is typically used by banks and other businesses to determine if you’re someone who’s responsible with money. Here are the three main areas where credit cards offer advantages:
- A credit card can help you manage your money. You can track and adjust your monthly spending with a simple review of your monthly statement, which may also help with your monthly budget.
- Credit cards give you more ways to buy things. They are accepted worldwide, even where cash and checks may not be accepted, (e.g. hotels, car rentals, mail or telephone orders or online shopping).
- A credit card can also afford you a little peace of mind since you can use it as payment in emergencies or to cover larger, unforeseen expenses, such as car repairs, medical emergencies, new appliances, etc.
- Carrying a credit card offers more security than carrying cash and it gives you zero liability protection against unauthorized purchases.
- Many cards have grace periods that last as long as 25 days, essentially giving you an interest-free loan for nearly a month before you have to pay off your balance. The best practice is to pay your balance in full each month.
- You can use a credit card to cover short-term costs until your next payday so you avoid overdraft fees on your checking or debit card account.
What’s a credit score and why is it important?
A credit score—sometimes referred to as your FICO score—is a widely used calculation of various factors concerning your credit history and current credit accounts. Financial institutions and other companies use your credit score to determine whether you’re someone who is responsible with your money (which includes meeting the terms of your credit card agreement).
Credit scores range from about 350 to 800. A low score indicates poor credit history and makes someone a high risk for credit. A high score, which indicates a good credit history, can give you many advantages, including better interest rates and higher credit limits on things like credit cards, mortgages and other types of loans such as a new car loan. It also lets landlords know that they can trust you to pay your rent on time each month.
What factors determine your credit score?
Factors affecting a positive or negative credit score:
Payment History: Overdue bills or late payments will lower your credit rating.
Amount of Debt: In general, your non-mortgage credit payments each month should not exceed more than 15 percent of your after tax income.
Responsibility and Stability: Staying at one address and at one job for extended periods of time (usually at least two years) are viewed as positive signs.
Unused Credit Cards: The credit rating formula looks at the difference between the amount of credit a person has and the amount being used. Closing one or more credit card accounts reduces your total available credit. This, in turn, lowers the percentage of available credit, which ultimately lowers your credit score. The formula also factors in the length of time your credit accounts have been open. So before you close an account, talk to your bank or get advice from an experienced financial advisor.
Number of Credit Inquiries: When you apply for credit, you authorize lenders to ask for a copy of your credit report from a credit bureau. When you check your credit report after such an inquiry, you may notice that inquiries are listed. That’s because inquiries from lenders directly affect your credit score since lenders assume that multiple inquiries are a sign that you’re looking for loans, which may make you a poor credit risk. You can help your credit rating by keeping credit inquiries to a minimum.
Stay on top of your credit score
It’s a good idea to order and review your credit report every year. Everyone is allowed to get one free credit report every year. For a free copy of your credit report, you can go to www.annualcreditreport.com.
Otherwise contact these major credit bureaus:
Check your report for any inaccuracies and if you need to dispute errors, contact the reporting agency to explain the disputed items. You can request an investigation, send copies of supporting documents and tell the creditor that you are disputing an item.
Seven ways to use credit responsibly and avoid getting into debt
1. Be sure to check your monthly statement to see if all charges and payments have been reported accurately
2. Only purchase items you can afford to pay back in a reasonable amount of time; if you know you can’t afford something, don’t buy it
3. Do not exceed your credit card limit
4. Pay more than the minimum due if you can. You’ll reduce the time it takes to repay your credit card debt and save money by paying less interest
5. Keep unpaid balances low—borrow only what you can repay in a given time period
6. Do NOT miss a payment or pay late. If you do, you’ll be charged fees and additional interest
7. Know the interest rate on your card and read the terms and conditions of your account to familiarize yourself with all possible fees, such as those applied for cash advances
MasterCard believes that informed consumers are better equipped to enjoy the financial freedom a credit card offers. To learn more about credit cards and financial responsibility, MasterCard encourages you to visit the Learning Center at www.mastercard.com/education