What we'll cover
The difference between credit and debt
Different types of credit and debt and how they work
How to use credit responsibly and manage debt
From how you spend to how you save, your overall financial picture is made up of countless details, but two important aspects are debt and credit. How you manage both can have a big impact on your financial future.
What is credit?
In general, credit refers to the ability to borrow money with the understanding you'll pay it back later, often with interest. When you don't have enough cash to pay for a purchase upfront, credit can be a good option. Your credit score is a three-digit number that reflects your credit behavior (a.k.a. how likely you are to pay back a loan on time) and helps lenders determine how much credit you're eligible for.
When you don't have enough cash to pay for a purchase upfront, credit can be a good option.
How does credit work?
In some ways, credit is similar to a loan. A lender — like a bank or credit card company — approves a borrower for a certain amount of money. You can access the money via a credit card or via a line of credit. The borrower must pay back the money to the lender according to the terms of the loan, which usually includes interest.
Types of credit
Credit can fall into one of many different categories, but the two most common are:
Revolving credit
Credit cards, home equity lines of credit, personal lines of credit and business lines of credit are all considered forms of revolving credit. This type of credit is open-ended, and you can keep using it and paying it down as much as you want as long as the account remains open and in good standing.
Revolving credit usually has a maximum limit you can borrow. When you make a charge or use the money, the total balance available to you decreases. Every time you make a payment, your total available credit to use will increase again.
Installment credit
Mortgage loans, car loans, student loans and personal loans are all considered installment forms of credit. This type of credit is usually paid back on a fixed schedule (usually monthly) with the same amount of money due at each interval. In the case of car and home loans, the car and home are used as collateral, meaning they can be taken from you if you fail to pay back the loan.
What is debt?
When you borrow money that you need to pay back, that's debt. The money you owe on your car loan, credit card and mortgage are all forms of debt.
Read more: How to use buckets to pay off debt
Good vs. bad debt
All forms of debt are not created equal. Some debt comes with assets that can appreciate in value over time. A good example is a mortgage loan. Ideally, once you have paid off your mortgage, you now have an asset that's worth more than you spent on it. If or when you choose to sell your home, you could end up with a hefty profit.
Student loans and business loans are other types of debt that can help you achieve a goal now that will result in future financial gain.
Some debt though, like credit card debt, is not seen as favorable. When you rack up credit card debt, it's not an investment. You'll have to pay it back — plus interest — and credit cards typically come with much higher interest rates than those on student loans or mortgages. And unlike those types of debt, there's no home or career at the end of it to make it all worthwhile.
How to manage debt and credit
Credit is a tool to help you pay for the things you want and need from a home to a car and your education. But it's important to manage the resulting debt responsibly. To keep your debt under control and strengthen your credit score, make an effort to make payments on time.
Check your credit report often so you can take action if changes need to be made. Don't take on more debt than you can reasonably afford. Whenever possible, make more than the minimum payment.
Tip: Use our free credit card calculator to map out your payment plan.
Boost your financial future
When you're dealing with the costs of today, it can be challenging to keep your eye on the big picture of your financial future. By getting smart about debt and credit and how to manage both effectively you can make sure your money choices today pay off for the many tomorrows ahead.
