Module 3: What is Credit?

FINANCIAL LITERACY LEARNING RESOURCES 

Introduction to Credit

Credit is a key concept when it comes to managing money, and it plays a big role in our everyday lives, even if we don’t always notice it. Whether you’re saving up for something special or planning to make a big purchase, understanding credit is essential. It’s about borrowing money, using it responsibly, and paying it back over time.

In this guide, we’ll explore credit in a simple way that makes sense for kids and teens, breaking it down so that you can understand the importance of borrowing, lending, and how credit affects your life.

1. Introducing the Concept of Borrowing and Lending Money

Let’s start with something basic: borrowing and lending. Imagine you want to buy something—like a new video game—but you don’t have enough money right now. You might ask a friend or family member to lend you some money. When they agree, you make a promise to pay them back later. This is called borrowing. The person who gives you the money is called the lender.

Now, if you were the one lending your friend money so they could buy something they need, you would be the lender. Your friend, who borrows the money, would have to pay you back over time. This is the essence of how credit works: it’s an agreement between a borrower and a lender.

a. Borrowing with Responsibility:

When you borrow money, it’s important to remember that you are making a promise to give it back. But often, you don’t just pay back the exact amount you borrowed. There’s usually an extra fee added to the total—this is called interest. The interest is what you pay the lender for allowing you to use their money. For example, if you borrow $100 from someone, they may ask you to pay them back $110. The extra $10 is the interest.

b. Lending with Trust:

When you lend money to someone, you’re trusting that they will pay you back. Just like when you borrow money, the person borrowing from you might have to pay extra money in the form of interest. Lenders charge interest to make it worth their while, because they’re letting someone else use their money instead of keeping it for themselves.

Now that we understand the basics of borrowing and lending, let’s dive deeper into credit—which is how these concepts are used in the real world, especially by businesses and banks.

2. What is Credit?

Credit is essentially a system that allows people to borrow money from a bank or a company with the promise of paying it back later. When you use credit, you don’t have to have all the money for something right away. Instead, you borrow the money and pay it back over time, usually with interest.

For example, when adults buy a car or a house, they usually don’t have enough money saved up to pay for the entire cost right away. So, they take out a loan (borrow money) from a bank. The bank gives them the money upfront, and they agree to pay the bank back in monthly payments over several years. These monthly payments include both the amount they borrowed and the interest.

Credit can be used for all sorts of things, from big purchases like houses and cars to everyday items like groceries, clothes, and even online purchases. Many adults use credit cards for these kinds of purchases, and they pay back the money later when they get their monthly credit card bill.

a. How Does a Credit Card Work?

A credit card is a special kind of card that allows you to borrow money from a bank whenever you need to buy something. Each time you use the card, you’re borrowing a small amount of money from the bank. At the end of the month, you receive a bill that shows how much you borrowed. You then have to pay the bank back.

If you pay the full amount back by the due date, you usually don’t have to pay any interest. But if you can’t pay it all at once, the bank will charge you interest, which means you’ll owe more than you originally borrowed. This is why it’s important to use credit cards wisely—if you borrow too much or don’t pay it back on time, you could end up owing a lot more money than you expected.

3. How Does Credit Affect Your Life?

Credit isn’t just about borrowing money—it can also affect your future in important ways. When you borrow money and pay it back responsibly, you build something called a credit history. A credit history is a record of how you’ve handled borrowed money in the past. It shows whether you paid it back on time and how much you borrowed.

Banks and other lenders look at your credit history when deciding whether to give you a loan or a credit card. If you have a good credit history, lenders are more likely to trust you and lend you money in the future. If your credit history isn’t so good (for example, if you didn’t pay back loans or credit card bills on time), lenders might not want to give you credit, or they might charge you more interest.

In short, having a good credit history is important because it affects how easy or difficult it will be for you to borrow money when you need it.

a. Credit Score:

A credit score is a number that represents your credit history. The higher your credit score, the better your credit. Think of it like a grade you get in school, but instead of measuring how well you’re doing in math or reading, it measures how good you are at managing borrowed money.

Your credit score can go up when you borrow money and pay it back on time, and it can go down if you don’t pay your bills or miss payments. Having a high credit score makes it easier to get loans, credit cards, or even rent an apartment. A low credit score can make borrowing more expensive because lenders charge higher interest rates to people with bad credit.

4. The Importance of Using Credit Wisely

Using credit responsibly is really important because it helps you avoid getting into too much debt. Debt is what happens when you owe money that you haven’t paid back yet. When people borrow too much money and can’t pay it back, they can end up in serious financial trouble. That’s why it’s important to be careful with how much credit you use and make sure you can pay it back on time.

a. Good Debt vs. Bad Debt:

Not all debt is bad. In fact, sometimes borrowing money is necessary and can even help you in the long run. For example, borrowing money to go to college is often considered “good debt” because it’s an investment in your future. A college degree can help you get a better-paying job, which will make it easier to pay back the loan.

On the other hand, borrowing money to buy things you don’t really need, like expensive clothes or video games, can be considered “bad debt,” especially if you can’t afford to pay it back. The key to using credit wisely is knowing the difference between good and bad debt and making sure you don’t borrow more than you can handle.

b. Budgeting:

One of the best ways to use credit wisely is by creating a budget. A budget is a plan for how you’ll spend and save your money each month. When you have a budget, you can see exactly how much money you have and how much you can afford to borrow. It helps you avoid borrowing too much and makes it easier to pay back any money you owe.

For example, let’s say you earn $100 a month from doing chores or working a part-time job. If you know that you need $50 for your expenses, like buying lunch or saving for a new gadget, you’ll have $50 left to spend or save. If you want to use credit to buy something more expensive, your budget will help you figure out how much you can afford to borrow and still pay it back on time.

5. How to Build Good Credit as a Teen

You might be thinking, “I’m too young to worry about credit!” But building good credit can start at an early age. Even though you may not have a credit card or a loan yet, there are steps you can take to prepare yourself for managing credit in the future.

a. Start Saving:

One of the best ways to build good credit habits is by starting to save money now. When you learn how to save, you develop the discipline needed to manage your money wisely. When you have savings, you’re less likely to rely on credit for everyday purchases, which can help you avoid debt in the future.

b. Learn About Budgeting:

Understanding how to budget your money is a key skill that will help you manage credit later on. Start practicing now by keeping track of how much money you have, what you’re spending it on, and how much you want to save. This will help you get used to making smart financial decisions.

c. Use Credit Responsibly When You Get Older:

When you’re old enough to get your first credit card or loan, make sure to use it responsibly. This means not borrowing more than you can afford to pay back, making payments on time, and avoiding unnecessary purchases. By doing this, you’ll build a good credit history, which will help you later in life when you need to borrow money for bigger things, like a car or a house.

6. Conclusion

Credit is a powerful financial tool that can help you buy things, invest in your future, and achieve your goals. But it’s also something that needs to be managed carefully. Understanding the basics of borrowing and lending, how credit cards and loans work, and the importance of paying back what you owe on time will help you make smart