Not All Credit Is Created Equal
Credit is simply a form of borrowing that requires you to pay back the lender (usually your financial institution) at a future date. You'll need to pay back the principal (i.e., the original amount of money you borrowed) plus interest (a charge in addition to the principal that compensates the lender for the use of their money).
Like most students, your first experience with borrowing money may be a credit card. You may also have a student loan, a line of credit, or overdraft protection.
Credit cards can be a safe, convenient way to pay for purchases and a lifesaver in emergency situations. They often carry the highest interest rates of any form of personal credit. Here's how they work:
- When you charge a purchase to your credit card, you aren't charged interest right away. In fact, you could use your credit cards interest-free, if you repaid the entire balance on each monthly statement by the due date.
- When you don't repay the entire amount on the statement by the due date, you are carrying a balance. In this case, you'll be charged interest, calculated from the date of your original purchase, every month until the balance is repaid.
- Even if you can't pay your entire credit card balance each month, it makes sense to pay as much as you can. Carrying even a small balance over a long period of time can be surprisingly expensive.
- Avoid making cash advances on your credit cards unless it's an absolute emergency and repay the entire amount as quickly as possible. Unlike regular credit card purchases, cash advances on a credit card are subject to interest charges immediately, until the entire balance is fully paid off.
Gas and retail store credit cards work much like bank credit cards but you can only use them at the gas station or store chain that issued it to you. Another important difference: interest rates on these accounts are usually much higher than other credit cards. Check out how much interest you're being charged and try to pay your bills in full by the due date.
Lines of Credit
Lines of credit let you access funds up to a set limit, anytime. They're convenient: apply once and when you're approved, you can access available funds easily by writing a cheque, making an ATM withdrawal or transferring the money online. As you pay down the amount you use, your credit limit becomes available to you again.
Most lines of credit require a minimum monthly payment of the total accumulated interest but otherwise, repayment terms are generally flexible. Because lines of credit give you a high level of financial freedom, it's important to use them carefully.
Interest rates are usually higher than those on a line of credit but lower than credit cards. You'll likely need to pay a fixed amount every month, on a pre-set schedule, until you've paid off the loan in full. While less flexible than lines of credit, a loan may be a good choice if you want to make sure the amount is paid in full by a certain date.
If you like to pay cash, write cheques or make direct debit payments, it's possible to spend more than you have in your account, resulting in a shortfall. Your cheques could "bounce" which in bank-speak means that they're marked "NSF" ("nonsufficient funds"). Embarrassing, of course - but more signficantly, NSF cheques can affect your credit rating.
With overdraft protection, your bank will cover the shortfall in your account, up to a certain amount. You'll pay interest on the shortfall until you repay your account.
Next: Six ways to help you pay less interest