A Credit and Money Primer

Let's take a moment or two to clear a few things up. Credit isn't borrowed money. It's the ability to borrow money. The borrowed money itself is called the loan. Therefore, if someone – such as a bank or department store – gives you credit, it actually means that they'll allow you to borrow money in order to buy something. It also means, however, that they'll want to be paid back – and not just what you borrowed, but an additional amount known as interest. You should take a great interest in interest; it can be described as the cost you pay for borrowing money – in other words, it's the lender's profit. But we're getting just a bit ahead of ourselves. In order to really understand credit, you need to know a little something about money. Ah, we hear you smiling…

Just what is money, exactly?

So, you like money, do you? It's quite all right if you do; you're certainly not alone. Most people seem to have a fondness for it. But why is that? Well, quite simply, it's because money is the world's preferred medium of exchange, which simply means that it's the item that's most widely accepted in exchange for a seller's goods or services. In other words, you give the seller your money (also commonly known as currency), and the seller gives you the items that you want. If rocks were an accepted medium of exchange, you could hand the seller a bag full of them and get what you desired. (Wouldn't that be wonderful?) However, money is what's needed; people have been using it – in some form or another – to make purchases since ancient times.

Dollars and coins

Greenbacks, Dead Presidents, C-notes, dough, cake; regardless of the nickname used, they all refer to the same thing – cash. Dollar bills are paper money that represents a certain value. What value, you ask? Put bluntly, an amount of goods or services that a seller is willing to give you for the particular dollar's denomination (in other words, whether it's a 1-, 5-, 10-, or 20-dollar bill, for example). A grocer may decide to sell you a loaf of bread for one dollar, or perhaps two bags of groceries for $100 – which, at today's prices, isn't too far out of line.

That's the easy part. Unfortunately, it gets more complicated when you realize that these dollar values change all the time, even throughout any given day. That's a function of the Foreign Exchange market, but we're digressing.

Coins are money that has a certain amount of valuable metal in them, such as copper, silver or gold. But unlike paper money, which could actually become about as worthless as Monopoly money under extreme conditions, coins will generally maintain at least some real value because of the metals that they contain. As a matter of fact, many very old coins that are no longer minted (the process by which coins are made) are collector's items and have become very rare and expensive.

Currencies of other countries

Each country has its own official currency. For instance, the U.S. uses dollars. But so do Canada, Australia, and a number of other nations. Each one is different, however; Canadian dollars are used in Canada, Australian dollars in Australia, and so forth. Mexico, the Philippines, and various others use pesos. Again, Mexican pesos are different from the Philippine variety. Great Britain has their British Pounds, Japanese currency is called Yen, and the new European Union (often referred to as the EU) uses the Euro. Each of these currencies has different values in relation to the money of other countries. For instance, if you visited a foreign country and suddenly got hungry while you were there, you might be able to buy two loaves of bread for your dollar instead of just one. On the other hand, you may only be able to get half a loaf. It all depends on the value your dollar has in that particular locale. The table below will give you an idea of how much of the other currencies one U.S. dollar is equivalent to, but don't worry too much about what the exact values are; they'll change before, after, and quite likely during the time that you're reading this article. (At the time of this writing they were correct. However, by the time this article is edited, HTML-coded, and uploaded to the Web, the values will have changed twelve times. Add another twenty to thirty fluctuations before you actually read it and, well, you get the picture. Just use these values for illustration purposes only.)

1 U.S. Dollar equals: 1.01 Canadian Dollars
0.68 Euro
110.99 Japanese Yen
42.00 Philippine Pesos

Good and bad credit

Now that you've got a basic "feel" for cash (as if you didn't already), let's get back to using credit. No doubt you've heard the terms "good credit" and "bad credit." Without getting too technical, having good credit simply means that your ability to borrow money is high. You've probably borrowed before, you paid it back to the lender on time, and everybody was happy and thought you were great. Congratulations!

Bad credit, on the other hand, is basically just the opposite. You may have borrowed money and, for whatever reason, you didn't quite pay it all back on time – or maybe not at all. This (as you can probably guess) caused the person or company that lent it to you to get somewhat upset. Now, no one wants to lend anything to you anymore. Ever lend something to a friend and they didn't give it back, or it took forever for them to do so? If you have, then you probably understand the feeling.

When you use credit (that is, when you borrow money to buy something) you're giving your promise to the lender that you'll pay it back. And not only that, your promise will be backed up by a written agreement contract that both you and the lender must sign. The contract will spell out the terms of your agreement with the lender, such as how much money you're borrowing, when it has to be paid back, and the interest you must also pay. The contract is a legal document that gives the lender (and you, as well) legal recourse in the event that the other party doesn't do what they agreed to do. In other words, a complaint (or suit) can be filed and the document taken before a court judge who can enforce that the terms of the deal be carried out – if he or she so adjudicates.

Once your credit is fouled up, it can affect almost every area of your life. Bad credit can keep you from buying a house or car, and possibly even hinder you from getting that great job you want. Or, if a lender does agree to help you buy a car or real estate, you're going to end up paying a lot more for it then if you had good credit. That's because as your credit score gets worse, the interest rate you'll have to pay for credit will get higher and higher. And the higher the rate of interest charged on the money you borrow, the higher your monthly payments will be and, thus, the more you'll pay for your purchase over the life of the loan. (If you need help with building or reestablishing your credit, our Credit-Building and Management section is a good place to start.)

Look after your credit

So, it obviously makes sense to take good care of your credit. Once you start establishing a credit history with a credit card, department store (or merchant) account, or small personal loan, be sure to make those payments on time, and even pay early if you can. By doing that you won't have to worry about slow mail delivery or the company taking their sweet time in posting the payment to your account once they do get it. If you wait until the last few days before your payment is due, you'll be at the mercy of these and other possible inopportune events; and if your payment is late, the lender will surely charge you an additional fee.

Another great way to look after your credit is by paying your bill off completely every month. The reasoning is simple: most credit cards come with what's known as a grace period. This is a period of time that the card company allows you after your purchase before they begin charging interest. It can range anywhere from fifteen to thirty days, with the norm being from twenty to twenty-eight days. So, assuming your account allows a grace period, if you pay the full amount you owe when you get the bill each month, you'll be within that period of time and you won't be charged any interest at all. In effect, you'll be getting a free loan every month! But you have to pay the full bill each time; otherwise, interest will be charged and begin building up.

To sum it up, the best thing that you can do is to never let your credit get out of hand and go bad. Be careful and responsible about what you spend. Taking care of your credit now will allow your credit to take care of you later, and help make your life much more convenient and worry-free.

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