Tips for Teens: Understanding Credit

Once you turn 18, you might begin considering applying for a credit card, around the time you turn 21, you’ll likely start getting offers for credit cards or loans in the mail or online. Before you sign on the dotted line, make sure you fully understand what credit is, how it works, and the big impact it can have on your future.

What is credit, anyway?

Everyone talks about “credit,” but it’s rare to actually hear someone explain what it is. Simply put, credit is your ability to borrow money or to buy something without paying for it in full. How good your credit is depends on how likely lenders think you are to pay off your debt in the future.

How do credit cards work?

With a credit card, you can buy something now and pay for it later. You get a credit limit that determines how much you can owe at a time. For instance, if your limit is $1,000, you can make purchases that total up to $1,000 on the card. However, you won’t be able to buy anything else using that credit card until you’ve paid some of the money back. If you pay back $500, then that money is available to spend again.

If you don’t pay the money you spend back every month, your credit card debt collects interest. How much depends on the APR (Annual Percentage Rate) of your card. For young adults especially, these interest rates can be very high because you haven’t built up your credit.

Are credit cards bad?

Credit cards themselves aren’t bad – it’s all about how you use them. There are perks to paying with a credit card sometimes. Some companies offer protection on your purchases, cash back, and/or protection from fraud if you pay with their card. However, any of these perks can be outweighed by the crushing amount of interest you often have to pay if you let a balance build up on your card. It can take years to pay high credit card debt back – so long that the shoes you bought went out of style and you forgot if you even liked the movie you bought tickets for.

If you have good self-control and use your credit card to purchase only things that you have the money for, it can be a good tool to build credit. You can make the purchase and pay the card off in full each month to show potential lenders that you’re responsible.

How should I choose a credit card?

You’ll want to read the fine print and understand the terms and conditions of any card you choose. You’ll want to check the APR (Annual Percentage Rate) to know how much you’ll have to pay in interest if you carry a balance. You’ll also want to know if there are any fees, such as an annual fee. An annual fee is an amount of money you pay to the credit card company just to keep the account open.

When you’re younger, you may not have a lot of options for credit cards. As you build your credit, though, there will be more to choose from.

How can I build credit?

Sometimes it’s hard for young adults to build credit. Some lenders won’t approve you for a credit card or loan if you’re young and don’t have any credit history. Others may only approve you with a cosigner or for a very high interest rate.

One way you can build credit is through a secured credit card. A secured credit card is one that requires you to put the same amount of money as the credit limit in a separate account. This account “secures” the card. If you don’t make the payments, the money will get pulled from this account. This way, a company doesn’t have to be worried about whether or not you’re going to make your payments.

If you’re responsible with a secured credit card, it can help build your credit by showing potential lenders that you can pay your bill each month. However, if you miss a payment and they have to pull from the account that secures it, you will hurt your credit and show that you can’t handle the responsibility.

Looking ahead

Whether you use a secured card or choose a regular credit card, making your payments on time is the most highly weighted factor when it comes to building good credit.

To learn more about credit and the impact it can have on your future, check out the credit section of our WalletWorks page.

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