Credit lets people make purchases and get what they want today, even if they don’t necessarily have the money today, as long as they promise to pay the creditor back at some point in the future. This is an extremely useful purchasing tool, as you may not always have the cash to buy the things you need or want. Furthermore, even if you do have the cash, paying in the future in smaller payments could still allow you to have some cash in the present, which could be invested or put into a savings account and grow.
This is huge for buying houses and cars. Most people in their early 20’s, like me, do not have anywhere near the amount of money we would need to purchase a house or a new car. That is why we use loans. Loans are essentially a line of credit extended from a bank or lender, with the amount and interest rate they are willing to offer depending on your credit score.
Home loans are called mortgages, and allow people to buy a house now instead of after years of saving- much of which would otherwise go to paying rent for other housing. The interest rate on mortgages is often very low, because the value of the property acts as a security (in other words the bank can repossess the house if you don’t make your payments). However, even though the payments are low, because the payments are usually made over a period of around 30 years, you end up paying twice or even three times the value of the house.
Credit cards, as discussed in a previous post, are another form of credit. But credit cards are seen as luxury, so the interest rates and annual fees are often higher than other forms of credit.
Buying now and paying later with credit is a useful and necessary tool in the world today, and a big part of responsible use of credit is understanding just what the heck it is and why it is used. This knowledge can go a long way in helping you decide when you should use credit and how to avoid falling into debt- the biggest risk of using credit.
For more information on setting financial goals, as well as a variety of other topics, check out AIER’s Start Here digest. Dedicated to helping young people set their “life strategy,” the Start Here digest is a great resource for high school and college students interested in getting their financial lives on track. Best of all, it’s free!