Credit has become a significant element in our financial equation. Not that it must be, but we have made it so. This is because we’ve come to accept the idea that we need it to build and sustain our livelihood.
But do we really need credit to live a happy, fulfilled, and successful life? Is it possible that a person can become financially successful without the use of credit?
There are many billionaires today who can attest to the fact that you CAN get ahead financially without credit. Yet, the use of it could potentially be extremely hazardous to your financial well-being, as being experienced by more than 44 million Americans with student loans averaging $33,000.
Millennials make up a large segment of this group. Many of them, ages 25 to 34, are averaging roughly $42,000 in debt.
Misconceptions about credit
There are a number undesirable factors that are associated with the outcome of credit, many of which cannot be explored in this article for the sake of brevity.
One thing that has been made clear by many affluent individuals such as Warren Buffett is that you need to devise a method to stay away from credit if you want to get ahead economically.
To do so, however, you need to first understand its nature, which is something that is largely misunderstood by most younger people.
One example that comes to mind is this: In the past, I’ve engaged my younger audiences during presentations by asking a simple question: “When you use credit, whose money are you using?” The answers may surprise you:
- “My money,” most would answer.
- “The bank’s money,” some would reply.
- “The credit card company’s money,” others would respond.
In other words, they had no idea who owns the money that paid for their merchandise.
This is no small thing. Though there are many reasons why people get into financial trouble, the misconception of credit is a major contributing factor to the problem.
What is credit?
Simply put, credit is a privilege to use other peoples’ money to pay for what you need or want. This means that the funds you used through credit do not belong to you. They belong to others—investors who placed their money in the market for profit—and sooner or later, you must pay that money back.
There are several classifications of credit. Below are two of the most common ones:
- Installment credit – loans for houses, vehicles, education, furniture, etc.
- Revolving credit – money borrowed on bank cards, retail cards, gasoline cards, and so forth.
Credit is a convenient way to gain access to money. It allows you to take advantage of certain benefits when cash is unavailable, but the money is costly. The interest on a personal loan can be as high as 30 percent, and depending on your credit score, some companies will charge you as much as 40 percent for funds borrowed on credit cards.
These interest payments have the potential of adding up to millions of dollars over time, money that could make you wealthy under a different set of circumstances.
Knowing the four C’s of credit
Before you are given the privilege to use any form of credit, lenders will evaluate your circumstances by a set of criteria known as the “four C’s” of credit. They are listed below:
- Capacity – your ability to repay the money you intend to borrow.
- Collateral – an asset that provides the lender with some security if you cannot pay the loan. While some loans, like unsecured credit, don’t require collateral, others do.
- Character – your responsible use of credit. This has to do with how much debt you carry at any given time.
- Creditworthiness – your track record with credit, specifically how well you pay your debt obligations when they come due.
All this information can be retrieved from your credit history, which is the primary means by which lenders make their decision to grant or deny you access to credit. On your credit report is your FICO score or credit rating—a number ranging between 300 to 850 that gives the interested party a quick summary of your credit status.
For example, a score of 620 or less is considered bad. It tells the lender that you’re a high-risk borrower. A good credit rating ranges between 700 and 749, and an excellent one is 750 or higher.
Taking control of your credit
As a consumer who may need to use credit from time to time, you need to create and maintain a favorable credit rating. An ideal score should be a number between 700 and 750. The higher the score, the more likely you will be able to get access to the money you want and the less interest you will pay on the borrowed funds.
More importantly, whenever you borrow money for a purchase, keep in mind that you’re, in fact, using someone else’s money for your personal affairs. This means that you must exercise financial prudence and good judgment to avoid economic complications in the future.
The better outcome is to wean yourself from the use of credit, may be not altogether but enough put you in control over the situation. This means that you would choose when to use credit to your advantage. Here is a typical scenario: Holding onto your cash while using other peoples’ money to advance your financial agenda and paying little or no interest on the borrowed funds. The way to do this will be explained in more details in upcoming wealth-building posts.
Ultimately, the idea is to gain control over your personal finances. The more credit you use, the less likely this will happen. Instead, creditors will be controlling the outcome of your financial fate.
To learn more about credit and its effects on your economic well-being, consider reading my new book: Pennies to Power: How to Use Your 20’s to Gain Financial Independence for Life.
Thanks for reading.
What are your thoughts?
Is credit a good or bad thing? Is it possible to live comfortably without it? What good or bad things have you seen or experienced as a result of credit?