Essential Credit Concepts

Approach your relationship with credit intelligently. Here are some need-to-know concepts to assist you in that effort.

Approach your relationship with credit intelligently. Here are some need-to-know concepts to assist you in that effort.

Annual fee: Some credit cards, and most personal credit lines, charge an annual fee. As long as the account remains open, you'll need to pay it, even if you never use the card.

Annual percentage rate (APR): APR is the effective annual interest rate that you'll pay on debt. Financial institutions are required by law to disclose the APR of their programs so that you can compare the costs of different credit options.

Balance computation method: Lenders calculate interest fees by applying your interest rate to your debt balance. But what's your debt balance? It might be one number at the beginning of the month and another at the end. Most lenders calculate it by using the "average daily balance method." This is the sum of beginning balances for each day, divided by the number of days in the billing period.

Balance transfer: Moving debt from one credit account to another is called a balance transfer. Credit card companies often advertise lower interest rates on these transfers to win over new customers. Beware of fees associated with these transactions.

Cardholder agreement: The document that outlines all of the terms and conditions of a credit card account.

Default: When you fail to make required principal and interest payments, you're in default. Once an account is placed "in default," the lender will raise the interest rate, and probably assess fees. It's important to know in advance how your lender defines default: Is it one late payment, one missed payment, two late payments, or some other standard? You should also know the default interest rate on the account.

FICO: Your FICO score is determined by a complex mathematical equation that attempts to boil down your credit history into one number between 300 and 850. If you're number is higher than 750, you're considered to have excellent credit.

Finance charges: The amount of money that you're charged for interest on your balance.

Grace period: Most lenders allow you a certain period of time-usually 20 to 25 days-to pay your bill before you're assessed finance charges.
Introductory (or teaser) rate: This is a lower, temporary APR. The rate will reset to the account's regular APR after a specified time period, as defined in the cardholder agreement.

Minimum monthly payment: Your cardholder agreement should describe how your lender calculates the minimum monthly payment. For credit cards, the industry standard has been 2 percent of the outstanding balance; but this is changing. Many lenders are raising the minimum monthly payments to discourage out-of-control spending.

There'll be no quiz on these important concepts. The real test begins when you select an account and start using it.