Personal Finance 101: Why Do I Need Credit At All?

Samantha writes in:

I don’t understand why I need credit at all. Credit just gets you into debt and you wind up paying interest to other companies. What’s the point of throwing my money away like that?

pf101Samantha asks a really good question here – and in some respects, she’s spot on. Poor use of credit is a big net loss for people. Because of the interest payments, you lose far more than you gain.

However, there are a lot of upsides to healthy use of credit.

The Benefits of Having A Good Score

1. A good credit rating helps your insurance rates.

Insurance companies use your credit rating as a factor in determining what sort of rate to offer you on homeowners insurance, auto insurance, and life insurance. The higher your credit rating – meaning the more reliable you are at obtaining credit, then paying the bills faithfully – the better you seem as a risk, because people with high credit are statistically more likely to be safe drivers, safe homeowners, and likely to live longer.

2. A good credit rating helps you with employment options.

Similarly, many employers run credit checks on potential employees and, again, are much more likely to hire people with strong credit because it’s a clear indication that they’re reliable.

3. Credit often offers great buyer protection.

If you use credit to make a purchase – particularly credit cards – the cards offer a lot of protection against fraud, identity theft, and other serious problems. If you pay cash, you miss out on those protections.

4. A good credit rating helps you with renting.

Even if you’ve made the decision to entirely avoid credit and rent until you can write a check for a home, your credit still affects your housing because many landlords – particularly those in charge of higher-end housing – will check the credit ratings of potential renters and will reject (or charge a much higher deposit) people who have no credit or poor credit.

In the end, it pays to have a strong positive credit rating. This does not imply, however, that it’s good to be in debt. You can have a great credit rating without digging yourself into debt. Here’s how.

How to Gain and Improve Your Credit Score

1. Get a credit card.

If you have no credit history, you can usually get one with a low credit limit pretty easily. Look for one that has some sort of bonus connected to a retailer you use. If you shop at Target, get the Target Visa. If you shop at Amazon, get the Amazon Visa. If you get all your gas at BP, get the BP card.

2. Use the credit card for routine purchases.

If you stop for gas, use your card and pay at the pump. If you’re at the store buying some items you need and would buy normally, use your card for that routine purchase. Other than these events, forget about the card entirely.

3. Pay off your bill in full each month.

If you stick to just using the card for routine purchases, you should have no problem whatsoever paying off your entire bill each month. Thus, you never incur debt that generates interest.

Instead, you get all the benefits of a positive credit rating – lower interest rates, better job application success, buyer protection on some purchases, and better housing opportunities – plus the benefits of the rewards of a good credit card – discounts at the retailers you already use. Together, these add up to a net positive, and if you’re disciplined enough to keep yourself from using the credit card for purchases you would not make without it, it’s nothing but a positive.

Here’s another way to think about it. Your credit rating is simply the method many businesses use to figure out if you’re reliable or trustworthy. If you are, they see you as having more value – you’re likely to be a better employee, you’re less likely to have insurance claims, and you’re more likely to pay your rent. By avoiding credit, you’re sending no signal at all to them – and thus they’re unable to decide if you’re reliable or not and thus won’t offer you the best rates.

Positive credit helps you in many ways and saves you money consistently. Don’t avoid all credit because of a fear of debt – responsible people can enjoy all the benefits of good credit without the drawbacks of bad debt.

Good luck.

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