credit explained

Credit Should Have Been Explained This Way

Credit is really, really important. Don’t agree? Take a look at the United States National Debt figures. This country wasn’t built on paying for things with cash. Yes, our government hasn’t done the greatest job with managing debt over the years and that inability to effectively manage it has had a lasting impression on individuals when it comes to managing their personal credit.

For starters, most people have serious trouble defining credit. If someone were to ask you what credit is, would you be able to rattle off a simple definition? If not, don’t worry, credit can be summed up with this acronym, O.P.M. (Other People’s Money). Simple right? Now, depending on what source you reference, you may see a definition similar to this; credit is the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future. But why is something that’s so fundamental to our country’s existence such a misunderstood concept?

The Urban Financial Services Coalition (San Francisco Bay Area chapter) was hosting a workshop on understanding the importance of credit. During the Q&A portion, a young man wanted to make a comment about how he learned about credit. He stated that his story was simple and one that should be shared with everyone. The young man’s story starts off with him being in college and his mailbox was full of credit card offers. He knew that establishing credit was really important, but didn’t know the first thing about it. Up to this point, he only heard things like how credit was bad and that you should avoid it all cost. Note: for those of you who believe that, please consider changing your opinion. The young man decided that he needed to seek counsel as it applied to getting this credit card and he reached out to someone who he knew was really good with money…his mother. Note: when seeking financial advice, please consider a professional or at minimum, someone who is actually good with money.

During this brief 10-minute conversation with his mother, the young man learned how to ensure that his credit would always remain stellar. His first question to his mother dealt with which card should he select and from which financial institution. He had offers from both banks and credit unions. His mother simply said pick the card that you think looks the coolest. Why on earth would she say that? Well, the mother knew that any financial institution sending such mail wouldn’t be offering a college student any great credit card deals. It would be their basic student card, which probably wouldn’t have an annual fee. And for applying, they would probably get a t-shirt or some other tchotchke.

The young man didn’t think picking a card was that easy and expressed to his mother that he “heard” that he should be concerned about the interest rate prior to applying for a credit card. The mother gave him a great lesson about interest that all should take heed. The interest rate will never apply to you if you pay off your bill in full each month. In case you missed it, it’s worth repeating. THE INTEREST RATE ON A CREDIT CARD WILL NEVER APPLY TO YOU IF YOU PAY OFF YOUR BALANCE IN FULL EACH MONTH.

Reader Challenge: Go out and survey 10 people. Ask the question: What is the biggest thing for you to consider when shopping for a new credit card? Chances are, 8 or 9 out of the 10 people who you ask will say the interest rate is THE most important thing. The sad thing is, if the interest rate is their top concern, then they have already lost. What they are telling you is that they don’t manage money well and are okay with overspending/living above their means and as a result paying their financial institution more money than they deserve.

Next, the young man asked his mother how he should use his brand new credit card. She said make a few small purchases each month and pay off the balance in full when you receive your statement. She informed him that his credit limit would probably be pretty low (it was $200) since he was new to credit, plus the fact that he was a college student. And unless it was a real emergency, he should NEVER get close to that $200 limit. She reminded him that spending on a credit card is like getting a 30-day, interest free loan. If you don’t pay off your balance in full, that dreadful interest will most certainly kick it. She went on further to explain, that as a result of him sticking to this simple process, the financial institution would probably raise his limit. She warned him that just because they raise his limit, doesn’t mean he should go spend more. He should stick to his simple plan on making a few small purchases each month and pay off the balance in full, no matter how high is limit may become.

As a result of that conversation with his mother, the young man never had issues with credit. Of course, his mother didn’t share with him all the moving parts when it comes to credit; like there being 3 credit bureaus, the credit score and how all 3 bureaus report it different, how your credit score is calculated, why checking your credit report from all 3 bureaus each year is extremely important, etc. The biggest thing the mother did for this young man was keeping it super simple. Many of us tend to complicate financial matters and it causes a ton of stress in our lives. This young man has always viewed credit in a positive light, primarily because his credit was indeed stellar, he actually learned how it worked and adopted a great habit early on. It also helped that the person he received the advice from was a great steward of credit.

Not all of us will be fortunate enough to have parents who understand credit and how the game works. Just imagine, what if everyone had someone break down credit prior to getting their first credit card, like this mother did for her son. Debt (credit card debt specifically) probably wouldn’t be much of an issue.

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