What is credit?

Credit is spending money you do not have yet. Someone hands you their money now, you hand it back later, and you usually pay something for the privilege. That is the whole idea, and every credit card, buy now pay later account and personal loan is a costume on top of it.

Borrowing with a promise

When you use credit, a lender gives you buying power today in exchange for a promise: you will repay the money, on an agreed schedule, plus whatever the deal costs. The lender takes a risk that you will not pay, and interest and fees are the price of that risk. The better your track record of keeping promises, the cheaper and easier credit becomes. The worse it is, the more expensive, until eventually nobody will lend to you at all.

The four parts of every credit deal

• The amount: how much you are borrowing, sometimes called the principal.
• The cost: interest, a percentage charged over time, plus any fees.
• The schedule: when repayments are due and how big each one is.
• The consequences: what happens if you miss a payment, from late fees to a mark on your credit report.

Why a promise is worth paying for

So why does the lender get to charge you anything at all, when all you did was agree to hand the money back? Two reasons sit underneath every interest rate. The first is time: a dollar the lender gives you today is a dollar they cannot use themselves until you return it, and money has other uses in the meantime, so they want paying for the wait. The second is risk: you might not pay it back, and the lender has to price in the share of borrowers who never do. Put those together and interest is simply rent on money, set higher when the wait is longer or the borrower looks less certain to repay. That is why the same person can be offered a cheap home loan and an expensive credit card in the same week. The home is something the bank can take back if it all goes wrong, so its risk is lower, so the rent on that money is lower too.

The four parts, on one purchase

Take a $600 phone bought on a 24 month plan and run it through the four parts. The amount is $600, the price of the phone. The cost, in an illustrative case, might be nothing extra if the plan is a straight instalment, or it might be buried in a monthly fee slightly higher than the same phone bought outright, which is worth checking before you sign. The schedule is 24 equal payments, one a month, so $25 a month if there is no interest added. And the consequences, spelled out in the contract, usually include a fee when a payment misses and the loss of the phone if you stop paying entirely. Once you can see those four parts, you can hold the plan next to paying $600 up front and decide honestly which suits you, rather than being told the phone is free because the word credit was never mentioned.

Credit is already all around you

You do not have to own a credit card to be using credit. A phone bought on a plan is credit. A buy now pay later purchase is credit. A car loan, a HELP debt for uni, an afterschool job advance from a parent: all versions of the same deal. Spot the four parts in each one and you can compare them honestly, which is a skill most adults never build.

What this looks like in your life

You are probably using credit already without calling it that. The mate who covers your ticket and gets paid back on Friday is extending you credit, interest free, on the strength of your promise. A tab at the canteen, a phone your parents pay off monthly, the pay later button on a pair of shoes: same deal, different costume. Getting into the habit now of naming the four parts out loud, before you agree to anything, is the single skill this whole topic is trying to hand you, because the products change every few years but the four parts never do.

Credit is not good or evil. It is an amplifier. Used deliberately, it lets people buy homes, start businesses and handle emergencies. Used carelessly, it turns small wants into long debts. The rest of this topic is about making sure you are the one holding the volume knob, and the next lesson starts with the most common costume of all, the credit card, and takes its version of the four parts apart piece by piece.