4 Things You Should Know about Credit
When you’re new to credit, there can be a lot of terms and habits that seem confusing to you, like collateral, compound interest, credit scores and minimum payments. What do these things mean, and why are they important? Read ahead to find out.
1. Collateral
What is collateral? Collateral is an asset that is pledged to a lender. They can seize this asset and sell it if the borrower defaults on their loan payments. This minimizes the risk of defaults and guarantees that borrowers take their repayments seriously.
Not every loan requires collateral! A collateral requirement is one of the key differences between an unsecured vs secured line of credit or an unsecured vs secured personal loan. So, if you can’t provide an asset to put up as collateral and you want a line of credit, you can try to apply for an unsecured line of credit online. In this case, you may find that the interest charges/fees are higher or that the credit limit is lower than the unsecured options’ — this is the lender’s way of mitigating risks without collateral.
What can act as collateral? There are several things that can act as collateral:
- Your home
- Your car
- Stocks
- Bonds
- Insurance policies
- Cash savings
- Valuables like fine art, jewelry and antiques
2. Compound Interest
Your credit account’s interest rate is how much the lender charges on top of your principal loan after a certain period of time.
So, what is compound interest? Compound interest is sometimes called “interest on interest.” Interest will make your principal larger. The next time that interest is charged, it will be applied to the larger principal — which makes it grow even more. With the help of compounding interest, your credit balance increases over time, even when you don’t make any additional transactions.
Compound interest is one of the reasons why you should try to pay your bills on time and in full. It will help you keep the balance under control.
3. Minimum Payments
Credit cards give users the opportunity to make minimum payments every month. The payment could be a fixed amount like $25 or a small percentage of your balance. Users can pay this amount when they can’t cover the entirety of their monthly bill and avoid a late fee. It’s an affordable solution when your budget is tight.
However, you shouldn’t get in the habit of only paying the minimum whenever your credit card bill comes in. It will make paying down your balance harder with every month that goes by. It could lead to a lot of trouble.
4. Credit Scores
A credit score is a number between 300-850 on your credit report that represents your credit risk to lenders. This score is determined by your credit experience — how many credit accounts you have, how often you pay your bills on time, and how much you still owe. The higher your score sits on the scale, the less of a risk you’re believed to be.
What if you think your credit score is too low? There are lots of things you can do to improve your credit score over time and make yourself look more appealing to lenders. The score isn’t set in stone.
Knowledge is power. Now that you know exactly what these things mean, you’re sure to make better credit decisions in the future.
Photo by Ivan Samkov from Pexels
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