Credit is one of the most central elements of personal finance; countless parts of everyday life revolve around it. Unsurprisingly, having “good” credit (a strong record of credit usage and on-time payments) is extremely beneficial, while having “bad” credit (repeatedly missing payments on loans, credit cards, car payments, etc) is not only harmful but also financially crippling. Making even a minor mistake when handling credit can be detrimental at a young age, so in today's article, in an effort to hopefully dissuade readers from being irresponsible, I’ll be going over some of the consequences of damaged credit. The goal of this article is not to scare you away from using credit, but rather to encourage you to manage credit carefully.
The first and foremost concept to remember when using credit is that it is not free money. It is simply a loan; you are borrowing money that you will have to pay back later. Before using credit in any way - taking out a loan, making a payment using a credit card, etc - make sure you have the ability to pay the purchase back. As long as you only purchase items you can afford and pay off any outstanding debt on time, you should be fine. To learn more about credit and handling it properly, check out this article.
Before we discuss the consequences of damaged credit, let's discuss how your credit can actually get damaged. In short, if you miss a payment on some form of credit, like a student loan or credit card, your credit will get damaged. This will cause your credit score to drop and the missed payment will appear on your credit report (if it's over 30 days overdue). If this is the result of missing just one payment, what happens if you miss multiple payments? Well, depending on the number of payments you missed, you may default on your loan. For some loans, missing just one or two payments will result in default. For other loans, like certain types of student loans, you can miss up to 6 payment periods (one payment period is usually 30 days) before defaulting. Defaulting is one of the most harmful things that could happen to your credit. It causes a massive drop in your credit score, shows up on your credit report, and makes borrowing money extremely hard. Recovering from a default takes many years, and is a long and arduous process.
Now you might be thinking, “that isn't too bad, it doesn't really affect my day-to-day life”. This is a common misconception, and the opposite is actually true.
Your credit is checked by landlords when you're moving into a new apartment or renting a home to make sure you're a reliable tenant, and you can’t even think about buying a home, as getting a mortgage will be either ridiculously expensive (insanely high-interest rates) or impossible for those with bad credit.
Similarly, getting even a simple car loan will be very expensive, and you’ll be subject to high-interest rates which will make your monthly payment much higher than normal. It will also be difficult to get a normal, unsecured credit card. You’ll almost certainly have to get a co-signer (someone who is equally as responsible for the credit card debt as you, they will have to pay any debt back if you can’t), or get a secured credit card, where you're obligated to keep a certain amount of cash with the creditor before getting access to a credit card. Even then, you would be subject to extremely high-interest rates.
High interest rates mean that a seemingly affordable item can become too expensive for you to purchase; an interest rate of 20%+ means instead of paying $300 for a car, you’ll be paying $360 a month, adding up to a whopping $720 in interest alone in one year, over two months of payments. In many cases, this forces those with damaged credit to take on even more debt to pay off their initial debt, leading to an infinite cycle that results in a massive amount of debt.
Earlier, when I said credit infiltrates almost every aspect of your life, I meant literally every aspect. Many jobs, especially those that are in fields revolving around money (accounting, finance, etc), will also check your credit history to make sure you're not going to commit fraud or a similar financial crime and to check if you're going to be a responsible employee.
With all that said, I want to reiterate that the purpose of this article wasn't to scare you away from utilizing credit, but rather to encourage you to use it responsibly. If you want to learn more about some tips on handling credit, check out this article. Remember, credit can be extremely beneficial if handled properly, but equally as harmful if you're irresponsible. Thanks for reading, and I’ll catch you next Wednesday.