"Remember that credit is money." 
Benjamin Franklin 

When it comes to credit, that old phrase “there’s no such thing as a free lunch” couldn’t be truer. Credit is not free. No doubt about it, credit is a valuable resource—good credit is necessary to buy a new home, finance a business venture, or fund higher education. However, abused or over-used, credit can threaten your financial security before you know it. Learning the basics of getting and keeping good credit will help you avoid the potential dangers while you build a strong financial foundation.

From frills to necessities, the uses of credit are virtually limitless, and there lies the all-too-inviting trap. The friendly smile of the salesclerk as she sweetly asks, “Cash or credit?” and the ease with which we answer by whipping out a credit card, may be inuring us to the true financial impact of that seemingly simple question.

If you are among those answering “credit,” you are not alone.  Between 1989 and 2001, the credit card debt in America almost tripled, from $238 billion to $692 billion.  The consumer-driven marketplace gives a certain cachet to credit—we are encouraged daily to just “charge it” for everything from incidental and everyday expenses to luxury purchases, from groceries to Ferragamo designer handbags. But it is important to remember that this message comes from the very people who benefit with every purchase we make. They have their own best interests—their profit margins—at heart, not ours, when they extol the virtues of buying on credit.

This climate makes it very easy for us to forget that when we pay on credit we are really creating a short-term loan. Every time we use our credit card, we are borrowing money (principle), and paying additional money (interest) for the privilege of doing so.  For example, if you use a store credit card to purchase a television that costs $600 and you take a year and a half to pay for it, that television will end up costing you $676 (at an average credit card rate of 8%). And if you are only making the minimum payments on your credit card, you are extending that term out for 30 years, long after the life expectancy of the set.  That $600 television could end up costing you $6,561.

The Upside—and Down—of Credit

Credit is most definitely a two-edged sword. On the upside, it’s convenient. Most of us keep a credit card in our wallets “just for an emergency,” yet we use it for purchases that are less than critical. But that can be OK. Having a credit card with you can save you money on your purchases by letting you take advantage of store sales when you don’t have the cash immediately on hand. Assuming, of course, that you are diligent about paying for the purchase during the grace period, before the interest charges kick in. Unfortunately, credit also encourages impulse purchases, making it easy for you to incur substantial debt.  With average interest rates running anywhere from 8 – 18% (and even higher), the interest you pay can be a significant, almost hidden, drain on your resources, making it extremely difficult to build wealth. 

But before you decide to cut up all your cards and disavow credit altogether, consider this: Credit is a necessary evil, necessary to good financial health. Credit, in the form of a positive credit rating, enables you to acquire assets—like a house or a business—and can make dreams such as a higher education possible. A positive credit rating let’s the financial world know that you are a good credit risk, so that when you apply for the mortgage on your first home, the bank does not have to guess whether or not you will make your payments on time—they know you have a good track record. Those who have never had a credit card don’t have that history, which makes them a riskier investment.

The trick, then, is not to avoid having  credit cards, but to make judicious use of them. Before you use your card for any purchase, ask yourself if the item you are eyeing is something you really need or if you would be better off waiting and saving for the item.  Say you have been toying with the idea of buying a shearling coat to make the cold winter more palatable. You may find it a happy coincidence in your walk through the mall to find a boutique offering a one-day-only sale—20% off selected shearling coats. But before you plunk down your credit card, have you shopped around and made sure that this is the best price? A boutique shop’s sale price may still be considerably more than a designer warehouse’s everyday price. And don’t forget the example of the $6,600 television set—will the amount of the item plus accrued interest be less than if you waited and paid full price in cash? If not, then resist the siren call of “on sale, today only” and wait until you can buy that luxury coat on your own terms.

Thinking about these questions before flashing that credit card will help you avoid buying something you don’t really need and accumulating debt that you really can’t afford.