You can also use credit, which allows you to borrow money you agree to pay back within a certain timeframe, to help build your credit history or to pay for things you may not otherwise be able to pay for in full at the time. The trade-off is that you have to use credit wisely. If you don't pay back what you owe on time and in full, you can end up paying a lot more for something than it originally cost. At worst, it could lead you into debt.
While you must make borrowing decisions carefully, it's helpful to know that not all debt is bad debt. Credit can help you achieve important financial goals more quickly. For instance, you may need to take a student loan to pay for education expenses, a mortgage to be able to afford a home or a car loan to pay for a car you need to drive to and from work. Saving all the money you need for any of these goals can be unrealistic.
Keys for successfully using credit are to budget for the payments on the credit you use, make sure you don't owe more than you can afford to pay back and be sure to keep your borrowing costs to a minimum.
The more you understand about how credit works, the better you'll be able to make credit work for you. The two most common types of credit are credit cards and loans.
How credit works
When you use credit, you're borrowing money from a bank or other financial institution, known in this context as the creditor, and agree to pay back the amount by a certain date or on a particular schedule.
In exchange for the privilege of borrowing, the creditor charges you a percentage of what you borrow, called interest. The amount of interest typically accrues over the time you take to pay back what you owe. So, the more you borrow and the longer you take to pay the balance back, the more you'll pay in interest. And, if you miss payment deadlines you may also owe a penalty or late fee on top of the interest you owe.
To ensure you choose the card that will cost you the least, be sure to research all the fees fully before making a selection.
Potential lenders review your credit history by reading a summarized version of it called a credit report, or by looking at your credit score, which translates your creditworthiness into a number—the higher the score, the better.
With a loan, you borrow a specific amount of money called principal, which you must repay, plus interest, by a specific date in the future. You'll receive a bill each month and you must pay the balance in full.