Borrowed Money

Your life doesn’t always match up with your pay schedule. That is why it’s nice to know you can borrow money. One way to do this is through the use of a credit card. This option allows you to make small and large purchases alike and then pay them back over time. Responsible use of a credit card can also help you build credit, which you’ll need to take out future loans.

To determine if you should begin borrowing from a lender, ask yourself 3 simple questions:

  1. Do I really need this?
  2. Could I save for this and purchase it later?
  3. If I borrow money, how long will it take me to pay it back?

Once you provide an honest answer to each question, you can choose to take advantage of the convenience and purchasing power of credit cards.

Revolving Credit

Borrowing with revolving credit, which is what you’re doing when you use a credit card, is like having a loan you can keep open indefinitely. With a credit card, you’re given a maximum amount you can spend—referred to as your credit limit or credit line. Once you've reached that limit, you won't be able to borrow any more money until you've paid the balance back down below the limit. Some cards will approve charges above your credit limit, then charge an over-the-limit fee. Here are two examples to illustrate how credit cards work:

Overspender Savvy Spender
Credit Limit $500 Credit Limit $500
Billing Period 12/1-12/31 Billing Period 12/1-31
Monthly Spending Monthly Spending
12/2 Restaurant Charge $100 12/2 Restaurant Charge $100
12/6 Clothes Shopping $200 12/6 Clothes Shopping $200
12/13 New TV $350 12/13 Netflix subscription $8
Total Spent $650 Total Spent $308
Remaining credit line -$150 Remaining credit line $192
Over-the-limit fee $100 Additional fees $0
Interest rate hike From 13% to 20% Interest rate hike None

Each month, you can choose to pay less than the total due (as little as the minimum required payment), allowing the remaining balance to carry over into the following month’s statement. However, any unpaid balance will be subject to interest, which is a fee charged for the borrowed money. Keeping a balance from month to month means you’ll end up growing debt that accumulates interest charges.

An example:

Amount charged: $500
Interest rate: 10%
Minimum payment: 2% or $10, whichever is greater
Number of monthly payments: 65
Total time to pay off: 5.4 years
Total interest paid: $159.50

Credit vs. Debit

Credit and debit cards may swipe the same way, but you should know the differences between them. Credit cards are a form of borrowing, like a short-term loan, while debit cards are essentially an electronic check linking directly to your checking account. To understand how credit and debit cards compare, take a closer look at the chart below.

  Credit Card Debit Card
Source of funds Revolving credit line Tied to your checking account; not a loan
Spending limit Card issuer sets a credit limit based on your credit history; over-limit penalties may apply or your card may be declined if you spend more than the credit limit Limited to the funds in the account; overdraft and insufficient funds fees may apply if you spend more than the balance in your account
Payments Monthly minimum payment based on current balance Funds are debited from your account almost immediately; no additional payments are needed
Interest rate Dependent on each card’s rate; you won’t have to pay interest if your balance is paid in full each month No interest charged
Fees Could include annual fee, over-the-limit fee, late payment fee or bounced check fee Overdraft fees may apply if you have opted into a service and complete a purchase that is more than your available checking account balance
Effect on credit history Responsible use and timely payments can help to improve credit score; poor or no credit history may affect your ability to qualify for a credit card Your credit history will only be affected if overdraft fees on your account are not paid and are handled by a collection agency

Effect on Credit

How you use a credit card affects your credit history, one aspect of your credit report. Your credit history can affect your ability to receive a loan, employment or a place to live, so it’s really important to create a credit history that reflects responsible and intelligent financial habits.

Here is what you can do to begin building a positive credit history:

  • Use your card regularly
  • Make your payments on time
  • Keep your balance below your limit
  • Continue to use your credit card over an extended period of time
  • Regularly read your credit report to make sure it’s error-free

When you practice these tips and responsibly use your credit card, you’ll improve your credit and may even get a higher credit limit. With a higher credit limit and the same responsible practices, you can maintain a low debt-to-credit-limit ratio and further improve your credit standing—which will give you the opportunity to finance large purchases, such as a home, at lower interest rates.

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