The word "credit" is one that you may be familiar with but not fully understand. A lack of knowledge regarding credit can cause you to make bad choices that are costly and could harm you financially for years to come. As a college student, now is the time for you to learn what credit is and the different types of credit accounts that are available so you can make wise financial decisions.
What Is Credit?
There are some things you can only buy or receive if you have some form of credit. Having credit means that a lender has approved you and given you permission to borrow money from them that you're required to pay back, with interest, in the future. This doesn't necessarily mean that you will receive cash in your hands. Instead, in some instances the lender will pay a third-party upfront, such as a furniture store or car dealership, then you'll repay the lender in the future. Or you may receive a credit card that you can use to make purchases for smaller items like clothes or gas.
Different Types of Credit
There are several sources of credit available for people to borrow, but most of them fall into three main categories: installment, revolving and open credit.
Installment Credit
This type of credit is actually a loan that you receive in a lump sum. To repay the lender, you make fixed or monthly payments to them until you pay off the loan. Credit accounts that are considered installment credit or loans typically include student loans, car loans, personal loans and mortgages.
Revolving Credit
The type of credit you are most familiar with may be what is referred to as revolving credit. This type of credit is what you receive when you are approved for a credit card. It comes with a credit limit (cap on how much you can borrow) and allows you to pay for any purchase or service you want as long as you don't go over your limit. Payments for this type of credit are made to the lender on a monthly basis, but you can continue to use it as long as you still have credit available. If you reach your credit limit, you will have to pay down the balance before you can use this type of credit again.
Open Credit
When you pay your cellphone bill each month, you are using a form of open credit. This type of credit usually consists of smaller balances that must be paid in full each month. Charge cards, not credit cards, also fall under this category because they require you to pay off your entire balance each month, no matter how much it is. Other accounts within this category include utility bills and gym memberships.
Now that you know the three types of credit available and how they differ, you have a better understanding of what each of them can do for you.
How Different Types of Credit Affect Your Score
Every time you apply for credit, your account activity gets reported to credit reporting agencies on a monthly basis. These companies track your accounts, credit limits, interest rates, and late payments, then calculate your credit scores based from this information. While installment and revolving creditors report your information every month, open credit lenders don't usually do that unless you give them permission to do so or your account goes into collections.
Learn More >>> What is a Good Credit Score?
Why You Should Check Your Credit Scores
No one is perfect, including credit lenders. For this reason, it is important for you to check your credit report periodically and make sure your personal information and credit history are correct. Your credit score is based from this information and it’s important as many companies will use it to decide if they want to approve you for things such as a house, car, job or even more credit. If you find any mistakes on your credit report or signs of identity theft, you should report them to the credit agency immediately to get them corrected.
How to Build Credit
Sometimes it can be difficult to get credit for the first time. Here are some tips to help you start building your credit.
Apply for a Secured Credit Card
You may be able to build your credit by applying for a secured credit card. This type of card requires you to pay a deposit for the lender to extend you credit. Your deposit is then held by the lender and used only if you default on your account and can no longer pay. While this method will cost you money upfront, it's a good way to establish a history of paying off debt and making payments on time.
Become an Authorized User
Another option is to ask your parents or another family member with good credit to add you as an authorized user on one of their accounts. This will jumpstart your credit history as your family member's on-time payments will be reflected on your report.
These tips show that there's more than one way to build up your credit.
Use These Types of Credit Wisely
Having credit is a part of life and something that you should use wisely. It starts with educating yourself about your finances and putting what you learn into practice.
