A debt is simply something you owe to someone else. Usually, that means money. You could owe a debt to a bank, a doctor’s office or even your parents. When you buy something with a credit card, the amount you charge is considered debt until you pay off everything you owe.
Credit is the amount of money you could borrow. If you have a credit card with a limit of $500, that is the amount of credit you have available to you.
The most common debts in America are home mortgages, car loans, student loans and credit card balances. Some debts, like credit card debt, can be paid off in full every month. Loans, for a house or a car, are usually meant to be paid off over a long period of time by paying a set amount each month.
Those loans paid back over time are known as “installment” loans because you make a predetermined number of installment payments to pay off the debt. Credit cards and similar lines of credit are known as “revolving” credit because the amount owed can change from month to month or year to year.
It all impacts your credit scores
Regardless of the type of debt you have, making your payments on time is very important. It shows the bank that you’re responsible with money and you can be trusted to handle more of it. Banks report these positive payments to the credit bureaus which increases your credit score.
When you miss a payment, though, or if you have too much debt, lenders start wondering if you’re stretched too thin. More importantly, those missed payments also show up on your credit report (that credit history we mentioned earlier is part of your credit report) and can drag down your credit score.
Credit report: A running tally of all your open credit accounts, your personal information like address and workplaces. Closed accounts also will stay on your credit report, for up to 10 years in some cases.
Credit score: This is the numerical score given to all the components that make up your credit report (breakdown below).
Credit history: The running tally of your accounts, including how long you’ve had them and how well you’ve managed them.
Think of it this way: Your credit score is kind of like a report card for how well you handle your money; your credit report is an overview of all your credit files and your credit history makes up a portion of both your credit report and your credit history. Here’s a comprehensive explainer of credit reports, scores and the credit bureaus that compile all of your information.
Credit scores usually range between 300 and 850, with anything 670 and higher considered to be a good score.
Credit utilization: how much debt you have compared to how much credit you have
Credit history: how old your credit accounts are
Credit mix: the combination of credit you have, like credit cards and loans
New credit: how many new accounts you’ve opened
Is there such a thing as ‘good’ debt?
Not all debt is bad. In fact, debt is necessary to build your credit history. That doesn’t mean it’s time to start buying everything you see with a credit card. While some debt can be helpful, there is also bad debt, and it’s important to know the difference.
Some debt can help you achieve something that you may not otherwise be able to afford without debt. In 2019 69% of college students graduated with debt used to pay for tuition. If these graduates get a job and start a career they would not have been able to get without their degree then that debt could be a great investment in their future.
How you can build credit as a teen
If you’re interested in establishing a credit history while you’re still a teenager, Step is a safe and effective way to do so. The Step Card is a secured credit card that reserves the money you deposit in your Step account as you spend it. Step then automatically pays off what you have spent every month so you never have to worry about a bill or payments. This reports positive history to give you a positive credit score without the risk of missing a payment and never paying fees or interest.
Traditional credit cards, on the other hand, can cause financial troubles very quickly if you don’t pay them off each month. The average credit card interest rate for people with no or limited credit history can be steep. If you have a $1,000 balance, and you don’t pay it off in full, you could be charged 25-30% interest on top of that $1,000. If you still don’t pay your full debt off the following month, not only will you be charged interest on what you charged, you’ll be charged interest on the interest. That’s what’s known as compound interest. It’s great when it comes to interest you earn in a savings account savings account, but the devil when it comes to debt.
Just remember that cold, hard cash is a much better source for an emergency fund. Financial experts recommend that you set up an emergency fund to handle something unexpected, even before you begin saving for short- and long-term goals.
How to use credit responsibly
If you don’t have debt now, you probably will someday. Once you turn 18, credit card companies will be reaching out to you on a regular basis with offers that may be tempting. Beware, though: Many cards offered to young adults include very high interest rates and fees. If you can’t pay back what you spend, you could end up racking up debt with interest and fees you can not afford.
While credit cards can be very useful for building credit history, buying something you need or even having on hand in an emergency, it’s easy to let that spending get out of control. But as long as you can pay off your bill in full each month, a credit card can help, not hurt.
The most important lesson you can learn when it comes to spending money — whether on a credit card or just using cash — is to understand your wants versus your needs.
An important rule of thumb is that you should never treat a credit card like an alternate source of income. In other words, don’t forget that credit card money is the bank’s money, not yours. You’re going to have to pay it back, and that includes with interest if you need to do so over time.
Step’s mission is to improve the financial future of the next generation. The services we offer, including the Step Card, are designed to protect your money, help teach healthy money habits and equip you to make smart money decisions.