Understanding Bad Credit

Understanding Bad Credit

Understanding Bad Credit

Understanding Bad Credit

Credit and debt are not synonymous terms, although they are used interchangeably in our society. Credit can best be defined as the establishment of a mutual trust relationship between a lender and a borrower, which can be the loan of something other than money. For instance, if I lend my lawn mower to a neighbor in exchange for the use of his garden tiller, we have a credit relationship. I have extended credit (the use of my lawn mower), and he is indebted to me until I use his tiller. This is called a barter exchange and is commonly done in business.

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Debt, as defined previously, is a condition that exists when a loan commitment is not met, or inadequate collateral is pledged to unconditionally satisfy a loan agreement. Borrowing is not the only way to get into debt. A court decree in a lawsuit, for instance, can result in debt. But for the purpose of this article, we'll limit our discussion to credit related debt.

There are two important issues in the topic of credit: how to get it and how to lose it.

Many young people get into trouble with credit because they are desperate to establish credit and because it is easy for them to qualify for more credit than they can manage.

The very best way to establish credit initially is to borrow against an acceptable asset. For example, if you have saved $1,000 and want to borrow the same amount, almost any bank will lend you $1,000 using the savings as collateral. Usually the lender will charge from 1 to 2 percent more for the loan than the prevailing savings rate. So in essence, it costs about 2 percent interest to establish a good credit history. For a one-year loan of $1,000, the net cost would be approximately $20.

Then, by using the bank as a credit reference, almost anyone can qualify for a major credit card, although the credit limit would normally be the minimum amount. I don't mean to imply that everyone should get a credit card, or that everyone will be able to manage one properly. But credit is relatively simple to establish if you have already acquired the discipline of saving.

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