Understanding the Basics of Credit, Debt and Credit Cards

Used correctly, credit can be a financial tool under your control, rather than a source of long-term debt... and stress! 

• Your "credit limit" is how much you are allowed to borrow, whereas debt is the result of that borrowing.
• A credit card allows you to repeatedly borrow up to your credit limit, as long as you have paid the previous borrowings on time.
• Credit cards can be a great financial tool if used correctly; however, the ability to continuously borrow against your credit limit can create a vicious credit/debt cycle.

What Is Credit?

Credit can be defined as the capacity to borrow money or be able to use goods and services with an agreement that you’ll repay the lender at a later date. Examples of creditors include mortgage lenders and credit card companies.

Whether or not you are granted credit is based on the creditor's understanding of how likely it is that you will pay back the borrowed amount, plus the cost of borrowing, known as your creditworthiness.

What creditors use to determine your creditworthiness is discussed later in this article!

The Difference Between a Credit Limit and Debt

A “credit limit" refers to money accessible for borrowing. For example, purchases made with a credit card are on borrowed money. The maximum amount you can borrow from a lender such as your bank is your credit limit. 

On the other hand, debt is what’s borrowed but not yet paid back. How you manage your debt determines how much may be available to you in the future. 

The Difference Between a Credit Report and a Credit Score

 Your credit report and credit score are not entirely the same thing, although they do have similarities. Both will impact your ability to take on credit, such as opening a credit card account and taking out a mortgage on a home. 

Your credit report contains information relevant to deciding your credit score and is distributable to banks, credit card companies, finance companies or yourself upon request. A credit bureau keeps track of a credit report and receives information from its members, storing information such as:

• Basic personal information
• Credit check history
• Credit card applications
• Credit repayment records, including late payments on credit cards
• Bankruptcy records are removable if debts are repaid. Otherwise, records are disclosed for 5 years from the date of discharge
• Default records (i.e. not paying back a loan at all)

As for a credit score, both the amount of debt you acquire plus how you handle the debt impact it. A good credit score indicates that you are paying your bills on time and will likely pay lenders back. Having a good credit repayment history puts you in a good position to receive loans in the future  – essentially, the higher the score, the better. 

Note — If you believe your credit score, or some information in the credit report, is incorrect, inform the credit bureau of such errors. If, following a dispute, an amendment is made, you should distribute the amended report to all banks who recently made enquiries on you. 

Credit Cards 

Some will say that owning a credit card is one of life's signs that you’ve made it to adulthood. Issued by a financial company, a credit card allows you to make purchases through borrowed money, up to an acceptable limit. Rather than receiving all the borrowable amount (credit limit) in cash, the credit card holder can choose how much they wish to borrow. Unlike loans, a credit card allows you to repeatedly borrow up to your credit limit. To apply for a credit card, you must meet the bank’s eligibility criteria. 

Annual Percentage Rate

The annual percentage rate (APR) is the interest rate or the cost to you of each credit card transaction. In short, the lower the annual percentage rate, the less interest you'll have to pay if you don't settle your entire credit card bill when it comes due.

Note that you won’t have to pay any interest if you can pay off the balance by the due date. Banks usually allow customers a grace period of around 20-25 days – meaning customers can wipe out their debts without paying any interest at all. On the other hand, carrying a balance on your credit card will result in owing interest on your outstanding or remaining balance. 

There are various types of APR, which include: 

Purchase APR – This rate applies to all purchases made by credit card. This is the most important interest rate to take note of and should have a considerable impact when choosing your card.

Balance Transfer APR – The interest charged when moving your balance to a new credit card.

Cash Advance APR – The interest charged on any cash withdrawal. This is usually a higher rate than the purchase or balance APR. There is no grace period, meaning that you'll be charged from the day after your withdrawal. 

Penalty APR – The interest charged if you violate any of the terms and conditions of the card. Consumers should thoroughly review the terms and conditions of any credit card before committing to one.

Calculating How Much You Owe

If you miss the payment due dates, here’s how you can calculate how much you owe. Banks use a daily or monthly periodic rate formula, which varies from card to card, to calculate the interest you owe on your balance.

APR ÷ 365 days=daily periodic rate DPR

Interest charged+ (DPR × days in a billing period) × the account balance subject to the interest rate.

Note – accounts may have multiple APRs, meaning a calculation may be applied for each. Also, the interest charged generally starts from the due date, so try to clear your whole bill by then

UNDERSTANDING CREDIT, DEBT AND CREDIT CARDS. COMPLETED. ✅

Sources: 

1. https://www.moneysense.gov.sg/articles/2018/11/credit-reports-and-creditworthiness 
2. https://www.nibusinessinfo.co.uk/content/difference-between-assets-and-liabilities 
3. Header photo from Pexels