Having and using credit is convenient but it usually costs something and it needs to be paid back. It is important to understand the costs of different forms of credit. Some forms of credit may be easier to get than others, but they often come with a high cost.
If you are thinking of borrowing or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it. Then you should shop for the best terms. When applying for credit, there are three main terms you need to be familiar with:
1. Principal - the amount of money you are borrowing.
2. Interest Rate - what the lender charges you to let you use their money. It is a percentage of the principal (charged per year, month, or week.)
3. Fees - cover the lender's costs to review your credit application or to service your account (maintenance fees, service charges, late fees.)
Because it costs money to use credit, in general credit should be used for things that have a useful life beyond when you finish paying your debt.
Example: Ana and Tomas Velasquez recently bought their first house. They are throwing a huge house-warming party and Tomas really wants a new stereo to use at the party. It will cost $500. Tomas promised Ana that he would do his homework and find the best possible deal for them. He researched four options:
| Payday Lenders |
Rent-to-Own Store |
Credit Card |
Cash |
|
If Tomas gets a $500 loan at a payday lender with a biweekly interest rate of 20%, he would pay $100.07 every two weeks for 21 months for a total cost of $4,425.01.
|
Tomas would pay $13.99 per week for 18 months for a stereo from a Rent-to-Own store, costing a total of $1,109.22. |
Tomas could use a credit card to purchase the stereo. If the card interest rate was 24% and he only paid the minimum payments, the stereo, plus interest would cost $812.71. |
If Tomas waits to buy the stereo until he is able to save money to pay cash, it will cost him $500. |
| $4,425.01 |
$1,109.22 |
$812.71 |
$500 |
Tomas and Ana decide to borrow a stereo system and to save money each month so they can pay cash for a new stereo system in six months.
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