By: Nathan Grant
4 Official Terms for Credit Definitions you May Already Know
No matter what state your personal situation is in, everyone deals with a myriad of financial decisions each and every day, and juggling them can sometimes feel like you are running on autopilot. Do you even know what some of the money matters you face are officially called? Since April is National Financial Literacy Awareness Month, here is a look at 4 common credit-related terms and their exact definitions to give provide a little texture and understanding.
Last year, American household debt hit a record $13.21 trillion, so it’s safe to assume that most Americans are carrying debts and making payments towards them every month. It’s good to know the differences between the types of accounts you are paying on so you can take the right steps towards paying them off efficiently.
Revolving accounts allow you to borrow funds repeatedly, up to an approved maximum amount set by your lender. This max amount is known as your credit limit. It is up to you how much money you will charge and how much you will pay back each month beyond the minimum payment requirements. These types of accounts include credit and store cards and home equity lines of credit, or HELOCs.
If you don’t pay off your credit card balance completely by the due date, the result will be an outstanding balance “revolved” from one month to the next, and of course, interest fees, also known as finance charges, when this happens. Installment loans are types of financing where you borrow money from a lender one time and are typically paid back at a fixed amount over a fixed period of time. These are debts like mortgages, auto loans, and student or personal loans.
NFLM Tip- Pay your statement balance in full, rather than just the minimum payment, to stay interest-free while reaping the rewards of being a responsible credit card holder, unless you have a 0% promotional APR. Speaking of which…
You’ve likely heard the term “APR”, or annual percentage rate, thrown around before, but what exactly is it? It’s the amount that your lender charges you to be a borrower. For example, if you take out a personal loan, the terms will generally include an APR that’s a percentage of the total loan amount. As long as you’ve made all your payments on time, by the end of the loan term, you’ll have paid back the original cost of the loan amount plus the total interest charges that have compounded over the life of the loan. So essentially, if you strip away the amount of the loan itself, the difference is what it cost you to have the loan as determined by the APR.
As mentioned above, if you pay a revolving credit card balance in full each month by the due date, you can avoid interest entirely, with the APR having no cost to you. There may be different kinds of APR depending on the card, from the most common, purchase APR, to promotional APRs or balance transfer APRs. Like any major financial decision, be sure to do your research ahead of time to know exactly what you are deciding on.
NFLM Tip- Most people think that a high APR is a sole reason to avoid getting a certain credit card entirely, but since paying your balance in full each month makes it so the APR isn’t even a major factor, consider taking a second look at that credit card you might have had your eye on in the past.
Generally, people are aware that their credit reports determine their credit scores, but is that all that makes a borrower “creditworthy”? Creditworthiness describes how likely it is that you’re able to repay a debt according to the terms of your lender agreement. Essentially, it is about financial trust. And there are factors that help determine that trust, so it’s important to know how your trust is being measured.
Late payments on your credit reports make up a good percentage of your creditworthiness, with the negative effects being more severe depending on how overdue the unpaid amount is. If any of your accounts have been sent to collections, or if you have anything negative such as repossessions, foreclosures, or bankruptcies on your record, that is going to play a part in that trust as well.
The other factors are more of the same kinds of things that credit bureaus look at for determining your credit scores. Be mindful of things such as how many accounts with outstanding balances appear on your credit reports, the variety in the types of credit accounts aside from just revolving accounts, and the ages of all of your accounts. How often have you applied for new credit within the last year, and what percentage of your credit limits are you using on your revolving credit card accounts (more on that in a bit)? These will also play a role in determining your creditworthiness.
NFLM Tip- Check your credit reports regularly (there are free resources to do so) to stay on top of your creditworthiness so you can make more confident financial decisions when applying for new loans, credit cards, or even things like a rental property.
Your total amounts owed across all credit accounts relative to the sum of all of your credit limits is known as your credit utilization. It’s a factor that plays a sizeable role in determining your credit scores, and the general rule of thumb is that the lower your credit utilization, the better it is for your credit scores.
Knowing how the percentage works might make you want to take a second look at certain money moves you want to pursue or the types of purchases that you want to use a credit card for. Avoid sending negative signals to credit bureaus by keeping your utilization in mind when you use credit cards.
NFLM Tip- Avoid closing credit card accounts that are paid off completely if you don’t have to, even if you don’t plan on using the card. It will keep your overall utilization low and contribute to the average age of all of your accounts, another sizeable factor that goes into your credit scores.