You probably already borrow plenty of things in your daily life, and when you do, the concept is pretty clear. Whether you’ve borrowed your sibling’s shirt, your friend’s pencil, or your cousin’s favorite video game, the expectation is that you’ll use it for what you need and then give it back. The same expectation holds true when you borrow money in the form of credit cards or loans, but there are some key differences. This article will help you learn the basics of borrowing and debt.

Not All Debt is Equal: Good Debt vs. Bad Debt

Debt is when you owe money to another person, organization, or the government. But it’s not all the same.

You can think of good debt as a means of building a brighter future. That might mean taking out a government loan to fund your college education or getting a mortgage for your first home. These debts have value. You’ll go to college, learn valuable skills, and – ideally – get a well-paying job. You’ll buy a home, allowing you to become part of a community and perhaps raise a family, and that home might even grow in value over the years with the work you put into it. People who decide to start a business also need to borrow money in the form of loans and lines of credit – and this debt can also be very positive, helping to launch a potentially successful venture.

Then, there’s bad debt. This is money borrowed for things you don’t really need or can’t afford. When you repay the money you’ve borrowed from a credit card company, financial organization, or the government, you pay an extra fee on top of the original money you borrowed. This is known as an “interest rate” and is calculated as a percentage of the overall loan or line of credit, making borrowed money more expensive to pay back. This can turn into a big problem if you’re not careful.

How Credit Cards Work

Credit cards are small plastic cards that can be used in place of cash at many businesses and online. If you get a credit card, it has your name and an account number on it. Banks and other companies issue credit cards to people if they qualify through an application and proof of income. Unlike a debit card, which looks similar but is tied directly to the money you have in a checking account, a credit card borrows funds from a line of credit issued by the bank or company that you have to repay each month.

Here are some credit card terms you should know:

• Credit limit: This is the maximum amount you can borrow on your card.
• Interest rates: If you don’t pay back the full amount of the money you borrowed on time, you have to pay extra money called interest.
• Minimum payment: This is the smallest amount you have to pay each month to keep your account in good standing, but the bank or company will require you to pay extra interest until you can repay the full statement balance.
• Late fee: This is extra money you will have to pay if you do not make at least your minimum payment by its due date.

The Dangers of Overspending

Always try to pay off your credit card balance in full each month. If not, the interest charges can make your debt grow and grow, often to unmanageable levels. Credit cards can be handy, but they can also make it too easy to spend more money than you have, or will have within the month. It’s easy to overspend with a credit card because it doesn’t feel like you’re using real money.

How to Build Good Credit

It’s important to build your credit score, which is like a report card on how trustworthy you are in borrowing and repaying debts on time.

Many people’s first experience with borrowing is taking out a student loan to pay for some or all of their college education. Most student loans don’t require repayment until after you graduate, so you’ll start building credit when you repay that debt regularly. You might also take out an auto loan when buying a car. Lenders for auto loans include banks, credit cards, and dealerships, and you can build credit as you repay those loans, in the agreed-upon amount, month by month.

Using a credit card responsibly can also build your credit score, but you have to be careful. To build and keep good credit, remember:

• Pay bills on time.
• Don’t borrow more than you can pay back.
• Maintain a low credit utilization ratio, which means not spending up to your limits.
• Don’t apply for more than two credit cards at once.

A good credit score means you are doing a good job at handling money. It can qualify you for important things in the future, like:

• Apartment rentals
• Better mortgage rates for a house
• Better home and car insurance rates
• Lower credit card interest and higher limits
• Job opportunities

Borrow Wisely!

You’ve now learned a lot about the good and not-so-good parts of borrowing, debt, and credit. Remembering these tips for building credit and using credit cards responsibly can set you up for a more successful – and less stressful – life.

Knowing how to manage debt is an important step toward financial stability that will last a lifetime. There’s always more to learn about earning money, saving, setting up an account, and more. Contact us, we’re here to help!