We live in a credit-based society. Credit has become a convenient way to pay for things while using other people's money. It allows us to purchase items and services today, though we don't have to pay for them until later. Without credit in our lives it would be very hard to obtain the things we need and want like: cars, houses, electronics, jewelry, etc. Credit is a "promise" for repayment on a debt. The promise is an agreement between you and the credit card company, or lender.

There are five types of credit available to consumers today. Let's review:

1. Revolving credit - Credit cards are considered revolving credit. They allow you to pay for all or part of your debt balance on a credit card. They are considered unsecured and require no collateral when purchasing items and services. When revolving credit is extended to you, the credit card company or lender is trusting you to repay the debts you have created using their money. Issuing revolving credit can be very risky for the lender and usually carries a high interest rate.
2. Installment credit - Installment credit is used when purchasing automobiles, household appliances, furniture, education, etc. Installment credit is considered "closed-end" credit because the borrower and the lender have outlined the specific amount of money needed, a specific monthly payment, and a specific time in which the loan will be repaid.
3. Open charge credit - This type of credit is usually issued from small retailers. It's an open-end line of credit for 30 days. It's also referred to as "30 days same as cash." If you have this type of credit set-up you can purchase a specific item, sign a sales slip (merchant agreement) and go home with that item the same day. At the end of 30 days, the retailer will send you a bill. This bill is due and must be paid in full. There are no payment terms available.
4. Service credit - This type of credit is issued by utility companies. In most cases you have already used the credit during the month... like telephone, electricity, gas and water before you have paid for it. Service credit usually requires payment in full and is issued without finance charges, but you could receive a late fee if payment is not received by the due date.
5. Mortgage credit - Banks, credit unions and other financial institutions issue this type of credit. People obtain this type credit for the purchase of a home, condo or other real property. Mortgage credit is more complex than the other types of credit. Mortgage credit works like installment credit but credit approval is harder to obtain. Mortgage credit could take weeks even months for approval.

Credit can be, very costly. If you don't need it, don't use it. If you borrow money on credit you will pay the lender a finance charge (their profit) for the use of their money. The finance charge is the total dollar amount you will pay which includes interest rate costs and other cost such as service charges and possible credit insurance.

Example of the cost of credit: Let's say that you borrow $10,000 from the Bank to purchase a car. The interest is 12% on the auto loan and your monthly payment is $222.44 for 5 years. Your total cost for borrowing $10,000 is $3,346.67 or 26% of the original amount borrowed.

Solutions to reduce your loan cost: By shopping that $10,000 auto loan through other banks and credit unions you could reduce your total payback cost by either reducing the interest rate or number of years to pay. Review the comparison chart below. As you can see Bank C is the best possible loan to obtain. (Source: Bankrate.com)

When you're ready to apply for credit you need to understand how a creditor qualifies you for credit. Creditors look for the ability to repay a loan, willingness to do so and security. Creditors refer to these factors as the three Cs of credit: "Capacity, Character and Collateral."

1. Capacity - Do you have enough income to repay the loan? They also will compare your total income with all of your monthly living expenses and other obligations you might have. A creditor needs to know your capacity of disposable income (after all expenses are paid).
2. Character - Are you a good credit risk? Creditors will run your credit report to see if you have repaid other debts on time and how long and how often you borrow money and whether you live within your means. They also look for stability like length at current home address, if you rent or own your home and the length of time at your employment.
3. Collateral - Will the creditor be protected if you don't repay the loan? Creditors want to know what assets or collateral (security for the loan) you may have other than income for repaying the loan such as a home, savings, investments, or other real property.

When using credit, it should be done wisely and only if needed. Let's review the advantages and disadvantages of credit.

• Can purchase items now and pay later
• Doesn't require using your own cash
• No need to write a check

• You pay high cost to borrow money (finance charges)
• You increase your debt load and Debt-to-Income Ratio
• You decrease the amount that you should be saving in the bank
• You may put your property at risk (if you can't pay)
• Less money each month for household expenses
• Can easily overspend and create financial difficulties