Borrowing money makes it possible to afford things that you couldn’t otherwise, but make sure you understand what you’re signing up for to avoid falling into overwhelming debt.
Let’s be clear right from the beginning: when you pay for something with credit, you’re still on the hook for that money. Often, you’ll have to pay back even more because of interest. The type of credit you use and the specifics of the agreement will determine how much interest you’ll have to pay, the size and frequency of your payments, and more.
It’s extremely important to recognize that credit can be dangerous. If you borrow too much or at too high of an interest rate, you can end up owing more than something is worth or being in a position where you’re struggling to pay back everything you borrowed.
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Revolving credit is a type of credit where you can borrow, pay off, and borrow again up to a predefined amount of money. At regular intervals (usually a month), you’ll need to pay back at least a minimum amount. If you don’t pay off what you borrowed completely by that time, the unpaid amount will carry over to the next billing cycle and begin accruing interest. The most common examples of revolving credit are credit cards, HELOCs, and other lines of credit.
Installment credit is a type of credit where you borrow an amount of money all at once and pay it back in predetermined chunks or installments. These regular payments could last for only a few months or multiple years. Almost all loans are examples of installment credit, so that would include car loans, mortgages, and student loans.
The final type of credit, and one that you may not even think of as credit, is open credit. This is when you use something and then pay for it afterward in regular intervals. The most common examples of open credit are bills, like for your cell phone or utilities. You use the service on credit and then pay for what you used on your next bill. These types of bills don’t usually charge interest but will add fees if the amount isn’t paid on time or in full.
To be an informed credit user, you’ll need to understand these vocab terms.
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These rules can help keep you out of trouble:
How you use credit will have a big impact on your life. Good credit—where you use credit wisely and follow the steps above—can allow you to buy things you couldn’t get otherwise. Bad credit—where you spend more than you can afford to pay back—will affect your ability to borrow in the future. Learn more about this process here.
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