Have a credit card but don’t know how it works? Considering taking out a loan but not sure if you qualify? In the first of this two-part series, the Office of Consumer Affairs & Business Regulation (OCABR) and the Attorney General’s Office (AGO) outline the basics of consumer credit, why it’s important, and its benefits and costs. Read part two for guidance on managing credit.
What Is Credit?
Credit is when you purchase a good or service on contract and pay for it at a later date, usually with interest, according to Consumer.gov. Understanding how credit works and using it wisely is important because it shows creditors that you are able to repay money you’ve borrowed. Positive credit history gives creditors confidence when loaning you money, which can open more purchasing opportunities to you. Negative credit history does the opposite, and may become an obstacle in the way of your credit purchases.
Types of Credit
Credit typically falls within two categories: open and closed end. Understanding the differences between them will help you determine the best way to finance your purchase.
- Closed-End Credit — Closed-end credit is when you borrow a specific amount of money from a creditor for a particular purchase that you must pay back within a set period of time. Examples of this, according to the Federal Deposit Insurance Corporation (FDIC), include a car loan or mortgage.
- Open-End Credit — Open-end credit is when a creditor finances you with a specific monetary limit that you may use for various and repeated transactions. You then pay your creditor back in cycles (usually through monthly payments) or all at once. Examples of this include credit cards and home equity lines of credit.
Consumer Credit Rights
There are closed- and open-end disclosures that creditors must provide you with, in a form you may keep, before your agreement with the creditor is complete. These disclosures include the terms and conditions of the credit agreement, such as annual fees, your interest rate, and late payment charges. They must be written clearly, be easily readable in a table format, and must not contain anything unrelated to the disclosures’ content.
Creditors must also adhere to the Equal Credit Opportunity Act (ECOA) enforced by the Federal Trade Commission (FTC), which prohibits credit discrimination for reasons such as race, sex, marital status, or whether or not you receive public assistance. Creditors may ask you for most of this information, but they may not use it when deciding either the terms of your credit, or whether to give you credit. File a Consumer Complaint Form with the AGO if you believe you have been discriminated against.
Cost of Credit
While credit can be a valuable tool for you as a consumer, it’s best to keep the potential costs in mind when considering it.
- Fees, Interest Rates, and Penalties — Understand the annual fees, finance charges, and penalties set by the creditor, as they may significantly increase credit costs.
- Monthly Minimum — Know your monthly minimum on both closed-end and open-end credit transactions, and make sure that you pay on time. Skipping your payments may result in extra fees, while paying on time, and as much as you can above the minimum, can help you avoid higher interest charges in the long run.
- Grace Periods — Most creditors have grace periods where, for a limited time, no interest is charged on purchases as long as you pay your balance in full each month. Check to see if you have a grace period, and understand the terms if you do to avoid interest charges on new purchases.
- Additional Fees for Cash Advances — You may be able to get cash advances on your credit card. This gives you cash in hand but often comes at a high interest rate and may have associated transaction fees.
- Other Considerations — The AGO provides a list of other important aspects to consider when opening a line of credit, such as backdated interest, retroactive hikes in interest rate, and linking credit cards with checking or savings accounts.
Stay tuned to learn how to manage your credit accounts and build positive credit history in part two of this series.
Comment below or tweet @MassGov with your questions about consumer credit.
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