Credit Cards: The Basics

Establishing credit is an important step in building a credit history and creating a credit "reputation." However, credit can be a dangerous temptation that could cause headaches down the road if not used wisely. The first step in understanding how to use credit responsibly is knowing what credit is. Credit is essentially an agreement that you will pay in the future for goods and services you received today. There are two main types of credit, secured and unsecured. Secured credit is backed by some form of collateral, such as property or money, as a guarantee of repayment. Mortgages and car loans are examples of secured credit, while credit cards are typically granted as unsecured credit.

The Pros and Cons
Credit certainly has its advantages. It provides you with the opportunity to purchase goods and services today and pay later. It is typically safer and more convenient than carrying cash, especially in booking reservations or ordering goods from the Internet. Credit card purchases are recorded, and are more convenient and more flexible than checks. Credit cards can be very useful in emergency or "rainy day" situations where an immediate need for funds exceeds money currently available to you. Your bills are consolidated into one payment, and many credit cards offer benefits for use, such as frequent flier miles and cash back bonuses. Finally, obtaining credit helps establish a credit history, which is essential for credit reports and scores.

Unfortunately, there are some disadvantages to using credit. For one, interest and additional fees can be substantial, and increase the cost of each item over time. It's also easier to lose track of how much you may have charged and overspend on impulse buying, thereby creating financial struggles down the road. Unpaid credit card bills, as well as other poor credit habits, have the ability to negatively affect your credit score for years, significantly reducing your chances of qualifying for subsequent credit cards, loans or mortgages in the future. Furthermore, credit cards tend to present users with a false sense of security, and the expenses often do not equal potential perks.

The Responsibility
Using your credit cards responsibly is the key to building a good credit score. Individuals that obtain credit, stay below their limit and consistently pay more than the minimum on time typically have better credit scores than those who miss payments and hit or exceed their card limit. Credit cards are categorized as revolving credit, which allows the user to make purchases now and make repayments at regular time intervals for an amount greater than or equal to the minimum payment with interest. The minimum is usually a percentage of the outstanding balance.

Lenders will be most likely to extend credit to you if your credit reputation is good. Typically, a creditor will look at your credit report to determine your credit history, if you pay your bills on time and if you have a reliable and steady work record. They may also take into consideration what capital assets you have as security and what your capacity to repay the debt is.

Once you have been granted credit, it is up to you to use it wisely. Be sure you read the contract carefully, including the fine print. Never borrow more than you can repay, which is typically no more than 15% of your annual net income (excluding mortgage payments). Avoid impulse buys and always pay at least the minimum on time. It is better to pay more than the minimum to reduce the amount of interest you are paying over time, therefore decreasing the final cost of goods and services purchased. If you are having difficulty making your payments, do not hesitate to call your creditor and work out a new payment schedule. Finally, protect your credit carefully. Report any lost or stolen cards immediately and never give your credit card information out in an unsecured environment