Credit Vs. Debt

Be careful about building up your credit card debt with non-essential purchases.
i Jupiterimages/ Images

Credit is your ability to take on debt, while debt is the actual amount that you currently owe to creditors. In general, you are in a much better financial position if your available credit far exceeds your current level of debt. This makes you credit worthy when you do have good reason to borrow money.

Credit Basics

Credit serves as a backup source of funding when you don't have enough cash or liquid assets to pay for things you want or need. Mortgage loans, car loans, student loans, personal loans and credit cards are common sources of credit. In some instances, using credit for purchases, such as with a mortgage, car or student loan, might be your only option. These types of loans make financial sense. Other choices, such as using credit from high-interest cards to make non-essential purchases, do not make financial sense.

Credit Score

Your personal credit score is a tool used by lenders to assess your basic level of credit worthiness. The FICO scoring system assigns each person a number on an 850-point scale. Payment history, debt-to-limit ratios, length of credit history, account inquiries and account types all impact your score, according to MyFICO. Your payment history and usage have the biggest impact, affecting 35 percent and 30 percent of your score, respectively. The debt-to-limit ratio is a comparison of your actual debt to your available credit. For instance, if you have a $10,000 credit limit and carry a $3,000 balance, your ration is 30 percent.

Debt Basics

Debt refers to a financial obligation you have at the current moment. If you owe $100,000 on a mortgage, $10,000 on a car loan, $5,000 on a student loan and $5,000 on credit cards, your total debt equals $120,000. When you have debt obligations, you also typically pay interest to your creditors for extending you the opportunity to used borrowed money for purchases.

Pros and Cons

Debt usually carries a negative connotation since you owe people money. However, taking on debt to buy a home is a normal investment for many Americans. You build equity in the home as you make payments. Plus, the interest on loans where your home serves as collateral is usually tax deductible. It is the debt considered non-essential that tends to weigh more on your current finances and future borrowing ability. Overuse of high-interest credit cards puts people in a budget bind. The more debt obligations you have, the less free cash you have to spend going forward.

the nest