Understanding Credit

Overview:

In Module 3, we explored the importance of saving and investing. Now, in Module 4, we will delve into understanding credit and its impact on personal finances. Credit plays a significant role in accessing financial opportunities, such as loans and credit cards, but mismanaging credit can lead to financial challenges. In this module, we will cover the basics of credit, credit scores, and responsible credit management, with examples from recent news.

Learning Objectives:

• Understand the concept of credit and its importance.
• Learn how credit scores are calculated and their impact on financial opportunities.
• Gain insights into responsible credit management practices through real-life examples.

What is Credit?

Credit is the ability to borrow money or access goods and services with the promise of repayment in the future. Types of credit include personal loans, credit cards, residential mortgages, and lines of credit.

Importance of Credit

Generally, a good credit is essential for:

• Qualifying for loans and credit cards at favorable terms.
• Renting an apartment or purchasing a home.
• Obtaining insurance, utilities, and other services.

In the United States, interest rates are set by the Federal Reserve Board (FED), however, commercial banks add to this based on the credit condition of individual/joint applicants. The better the applicant’s credit condition, the better the rate and vis versa. The FEDs set the rates to drive economic conditions because rates can affect borrowing costs and financial opportunities for individuals and businesses.

Understanding Credit Scores

In the United States, credit scores, such as FICO scores, are numerical representations of an individual’s creditworthiness based on credit history and other factors. Factors influencing credit scores include payment history, credit utilization, length of credit history, types of credit used, and new credit accounts. There are 3 major credit bureaus that report credit scores, i.e., Equifax, Experian, and TransUnion. Typically, the score ranges between 300 and 850, a credit score of 640 – 699 could be considered fair, while 700 or above is generally considered good. A score of 800 or above is excellent. Most consumers have credit scores that fall between 600 and 750.

Responsible Credit Management

• Pay bills on time: Timely payment of bills is crucial for maintaining a good credit score.
• Keep credit utilization low: Aim to use only a small portion of available credit to avoid appearing overextended. Typically, aim to utilize less than 30% of your combined credit limit.
• Monitor credit reports: Regularly review credit reports for errors and fraudulent activity.
• Co-signing for other applicants: Ensure you only co-sign on a credit application with people you trust as their negative management of that account would also have a negative impact on your credit file.

Key Takeaways:

Credit is essential for accessing financial opportunities, but it requires responsible management to avoid negative consequences. Credit scores play a significant role in determining borrowing costs and eligibility for loans and other services. Responsible credit management practices, such as paying bills on time and monitoring credit reports, are crucial for maintaining good credit health.

Next Steps:

In Module 5, we will explore the basics of banking and financial services, highlighting recent developments in the banking industry and their implications for consumers. Stay tuned for Module 5: Banking and Financial Services with The House of Emmanuels Foundation.

Author,
Ogbeni Ridwan (Lawyer; Banker; IT Audit Manager)
Director, The House of Emmanuels Foundation
Raleigh, NC USA