5.1 WHAT IS CONSUMER CREDIT?
Learning how to manage consumer credit effectively by reducing reliance on
high-cost borrowing is an important component of financial success. In this
chapter, we first look at the types of consumer credit and then how to apply for
credit. This chapter examines the advantages and disadvantages of credit and
how to protect your credit and correct credit mistakes. Finally, it discusses credit
cards in more detail, including their risks.
5.1 What Is Consumer Credit?
Any time you receive cash, goods, or services now and arrange to pay for them
later, you are buying on
If you use credit for personal needs other than
home purchases, you’re using
You can borrow from a friend
or family member, a firm with which you do business, or a financial institution
(e.g., bank, credit union, insurance company). The most common types of con-
sumer credit are
Credit card accounts.
Home equity loans.
In each case, the lender lets you have the use of the money now and expects
you to repay it with interest, often over a specified time period. Before you decide
to borrow funds to make a purchase, whether through a credit card or a con-
sumer loan, you should be careful to evaluate the short-term and long-term
effects on your monthly cash flow.
The future payments, including the original purchase price and interest
charges, will reduce your net monthly cash flow and thus your ability to make
contributions to savings. Interest charges will increase the total cost of the prod-
uct you are purchasing. Thus, in deciding whether to pay cash, take money
from savings, or borrow the funds to make a purchase, you need to be sure to
consider the trade-offs between the cost of borrowing and the lost earnings on
Many types of consumer credit—most credit cards, for example—require
that you pay interest rates that are much higher than what you can earn on your
savings. If you have to pay 18 percent interest on your credit card and you’re
earning only 5 percent on a savings account, you’d be better off taking the money
from savings than borrowing the funds for the purchase. Sometimes, though,