What is Credit?
Credit is the option to borrow money, agreeing to repay it later, often with an added cost known as interest. People often use credit to cover expenses they can't afford upfront or to benefit from rewards and cashback offered by credit cards.
Those you borrow money from, including lenders, businesses, and service providers, are collectively referred to as creditors. These creditors determine whether to grant you credit by assessing your history of borrowing. If you have a consistent track record of managing credit responsibly, it's referred to as having "good credit," making you a trustworthy borrower in the eyes of creditors.
What is Debt?
Debt, unlike credit, represents money that you've already borrowed but haven't yet settled. Credit, on the other hand, is simply the capacity to accumulate debt.
When you make a ₹5000 purchase using your credit card, you're essentially incurring a ₹5000 debt. As you continue to use your card for more purchases, your debt gradually increases. Failing to pay off the entire amount you owe on your card typically results in the imposition of interest charges, which essentially represent the cost of borrowing money.
Every individual can handle a specific amount of debt, which is determined by their income, expenses, and unique financial circumstances. A prudent financial practice is to avoid taking on unnecessary debt that you can't comfortably repay. For instance, accumulating credit card debt through everyday purchases can strain your budget and create challenges in meeting your monthly obligations. Moreover, escalating debt levels may have adverse effects on your credit score.
How to Use Credit and Debt Wisely?
While it's advisable to limit your debt, it's not necessary to completely avoid it. Responsible management of debt often referred to as "good debt," can assist you in reaching personal and financial objectives, such as taking Mortgage loans to purchase a home or taking an education loan to attain a college degree.
Here are some strategies for handling debt prudently:
Ensure timely payments: It's crucial to make all your payments on schedule. Late payments can lasting on your credit report for up to seven years, possibly affecting your creditworthiness. Therefore, always strive to meet due dates.
Maintain low balances: Keeping your balances low, and ideally paying off your entire balance, can help you maintain a low credit utilization ratio. Credit scoring models evaluate your overall credit utilization across all your revolving accounts, as well as on individual accounts.
Avoid excessive debt: Relying on debt than you can realistically manage increases the risk of missing payments or, even worse, defaulting on an account. Such situations can damage your credit score, potentially making it challenging to obtain credit in the future.
Pay more than the minimum: Making payments that exceed the minimum required amount can reduce the amount of interest you accrue. Likewise, consistently using and paying off your credit card each month can pave the way for a strong credit score.