Montana State University



Office of Financial Education

177 Strand Union Building
P.O. Box 174180
Bozeman MT 59717-4180

Tel: 406-994-4388
Fax: 406-994-5488
Email: makechange@montana.edu

 

Types of Credit

Credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date. It allows you to buy now with the promise of paying later. Credit comes in several forms. By understanding how each type of credit works, you will learn to manage credit successfully.

1. Loans

Loans let you borrow money that must be repaid with interest. You can obtain a loan for a specific purpose, such as financing a new car, paying college tuition, or buying or renovating a home. Loans are generally divided into two types: secured and unsecured.

  • Secured loans are guaranteed by collateral, which is an item of equal or greater value than the amount of the loan, such as a car, home or cash deposit.
  • Unsecured loans do not require collateral and are made based on your credit score and ability to repay.

2. Installment Loans

Installment loans are made for a fixed amount at the time of your application and approval. This type of loan is repaid in fixed monthly payments over a specific period of time. The interest charges are included in the payments. Auto loans and mortgages are examples of installment loans.

3. Credit Cards

Credit cards are perhaps the most common type of personal credit. Unlike installment loans, credit cards allow repeated transactions up to a maximum credit limit, also known as your available credit limit. Each time you charge something, you are borrowing the money until you pay it back. If you decide to pay the money back over time, the credit card company adds interest charges to your account. Each month, you will pay a calculated amount until the borrowed amount is paid in full.

Credit Cards

What is a Credit Card?

A credit card is a card issued by a bank or business to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services later. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance.

Credit cards bill monthly, with a grace period built in that lets the consumer borrow short-term credit between the time they make the purchase and when it is due. If balances are carried over from month to month the user will be charged interest.

Credit cards are a form of borrowed money. Each time you use a credit card, you are using money that you will have to pay back later with interest.

What is Interest?

Interest can be earned or paid out, and it is always a percentage of the original amount of money involved in the transaction. Interest paid is the amount that a bank charges you for borrowing their money.

Simple interest: Simple interest is when interest can only be earned on the amount borrowed or invested (this amount is called the principal).

Compound interest: Compound interest is calculated not only on the money originally invested, but also on the accumulated interest.

Credit cards are easy to use because they give you instant buying power for items you may not otherwise be able to obtain; and because of this people can find themselves in debt quickly if they don’t have a plan. Credit card interest rates are typically very high and may range from 12% to 23%. The longer you take to pay the money back, the more interest you pay on the money you borrowed. Credit cards should be used only for purchases that can be paid in full at the end of the month.

What should you know before obtaining and using a credit card?

  • What is the interest rate?
  • What is the annual fee?
  • What is the late fee?
  • What is the over-the-limit fee?
  • Do they offer a grace period?
  • What is the credit limit?

Controlling Credit Card Usage

Credit cards don't put people in debt, people do. Credit cards are not bad, but using them incorrectly can significantly impact your financial future. To minimize the dangers to your financial health, choose your cards wisely; think twice before using them, and DON’T CARRY A BALANCE.

If your credit card doesn't help you save money or provide a useful reward at no cost to you, don't use it. There are plenty of places where your credit card will come in handy - just be sure that you don't let the cost of this convenience get out of hand.

The High Cost of Credit Cards...

You buy a TV at the local electronics store with a credit card.

  • Initial Cost =$3,500
  • Interest Rate on Credit Card = 21%
  • Minimum Monthly Payment =$80.00
How long does it take you to pay off the TV making ONLY the MINIMUM monthly payment?
84 Months (7 Years)

How much do you pay for the flat screen TV with interest?
$6,480

What are some red flags that you are misusing your credit card?

  • You pay only the minimum due on each account.
  • You use one credit card to pay another.
  • You are consistently charged fees (late, over-the-limit, cash advance).
  • You have reached the credit limit.
  • You rely on your credit card to buy groceries.
  • You are losing sleep.
  • You are hiding your spending habits.

How can you control your use?

  • Don’t keep them readily accessible.
  • Set a maximum balance that’s well below what the card issuer allows.
  • Never use your credit cards as an extension of your paycheck.
  • Keep low limits.
  • When your credit card company offers to raise the limit, decline the offer.
  • Don’t think of your credit cards as an emergency fund.
  • Pay your card balance in full each month.

Credit Report

A credit report is a record of your personal credit history. A credit report contains information about your borrowing history and is created by a credit bureau. A credit bureau is a company that collects your payment history from creditors, lenders, utilities, debt collection agencies, and courts. They report how much you’ve borrowed, how you’ve repaid, and other details about your borrowing behavior.

Where can you obtain a copy of your Credit Report?

What is on my Credit Report?

Your credit report will include personal identifying information such as your:

  • Personal Information (name, social security, address)
  • Public record information (bankruptcy, liens, etc.)
  • Accounts Summary/loans (outstanding balances, credit limits, payment history)
  • Employment history
  • Inquiries
  • Negative Items


It may also include a FICO® score. Your three-digit FICO® score ranks you based on the risk involved in lending you money.

  • Good Credit Risk:
    • This rating can lower interest charges on new loans and typically shortens the loan application process.
  • Average Credit Risk:
    • The loan application process may take longer because they will need to verify your income and assets.
  • Poor Credit Risk:
    • May be denied loans and credit cards, be asked to provide a cosigner, or be required to pay a higher interest rate. Scores in this range tend to make the credit process lengthy and complicated.

The rating scale may vary between agencies. If you have No Credit, it means there is no record of your ability to repay a loan.