understanding credit

Posted : January 29, 2018
Last Updated : December 17, 2019

understanding credit

Credit can be a valuable financial tool when used wisely. Understanding how credit works is the first step in developing a strong credit history.

What Is Credit?

Credit is the ability to borrow money. When you borrow money on credit, you get a loan.

You make a promise to pay back the money you borrowed plus some extra. The extra amount is part of the cost of borrowing money. This cost is also called interest.

If you use credit carefully, it can be useful to you. Not being careful in the way you use credit can cause problems.

You've probably heard the term "good credit." Having good credit means that you make your loan payments on time to repay the money you owe. If you have a good credit record, it’ll be easier to borrow money in the future. However, if you have problems using credit responsibly, it’ll be harder to borrow money in the future.

Why Is Credit Important?

Credit is important because it:

  • Can be useful in times of emergencies.
  • Is more convenient than carrying large amounts of cash.
  • Allows you to make a large purchase, such as a car or house, and pay for it over time.
  • Can affect your ability to obtain employment, housing, and insurance based on how you manage it.


Collateral is security you provide the lender. Example: You pledge an asset you own, such as your home, to the lender with the agreement that it will be used as repayment if you cannot repay the loan.

A guarantee is a form of collateral. Example: Cosigning is a form of guaranteeing a loan; if a person with no credit history asks another person to cosign a loan, the cosigner is equally responsible and has to repay if the borrower defaults.

In a secured loan, the borrower offers collateral for the loan. Example: Collateral is given up to the lender if the loan is not paid back. Home equity loans and home equity lines of credit are examples.

An unsecured loan isn’t backed by collateral. Example: Credit cards are often unsecured loans, although some are secured. Other examples include personal and student loans.

An asset is something valuable that you own. Examples: A car; savings and investment accounts; property, such as your home

Source: PlanningYourDreams.org

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understanding credit

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