Part 1. Understanding Credit: What it is and why it's important
What is Credit?
Credit is the term that describes the present purchase of a good or service, with an agreement between the buyer (debtor or borrower) and seller (creditor or lender) that the buyer will repay the seller at some future time for the original price (the loan principal) plus an additional amount (interest) charged . A buyer who enters into and successfully completes transactions of this kind establishes “credit” and becomes more trusted by other sellers as one who is likely to repay these types of obligations in a full and timely manner.
The Cost of Credit
The cost of credit is defined in terms of “interest,” or the amount that the lender charges the borrower for use of the money. This can be a flat fee, or it can be calculated as a percentage of the amount borrowed. There are several reasons why interest is a necessary part of credit. For starters, there’s always a chance that the borrower won’t repay the debt, and the lender needs to be compensated for taking the risk of losing whatever has been loaned. Also, the lender could be doing other things with the money or goods that have been loaned. If it’s a money loan, for example, the lender could be investing that money in stocks or real estate instead of lending it to the borrower. If it’s an item like a vehicle or furniture, the lender might instead have sold it to a different buyer for cash, without facing the risks inherent to a credit transaction.
History of Credit
Credit has been around for centuries, and originated as a way for people to acquire items that they might not be able to afford with a single, lump sum payment, but could afford by making a series of smaller payments. While the modern credit card has origins back into the 1700s, historians have found Mesopotamian writings dating to thousands of years B.C. that describe debtor-creditor relationships.
Credit Matters Today
Like most Americans, you need credit to live a full and prosperous life. After all, we rely on credit for important things every day:
- Home purchase or improvements
- Furniture and appliances
- Cell phones and Internet access
Unless you can somehow manage to live on a cash-only basis, it’s important that you obtain and maintain good credit. What’s more, as we’ll learn in the next section, your credit can sometimes affect career opportunities and the cost of goods or services like car insurance.
Credit Knowledge is Power…and Money!
Taking a few minutes to understand how to make credit work for you—rather than against you—can save you
time, hassle, headaches, and, yes, money. Lots of it. Let’s learn more about how credit works