Understanding Credit And Debt: Key Differences

What is Credit?

What it is: Credit represents your borrowing capacity, a trust extended by a lender based on your ability to repay.

Purpose: It allows individuals and businesses to make significant purchases or access resources they may not afford with cash upfront.

How it's earned: Lenders evaluate your creditworthiness using your credit score, payment history, and other financial factors.

Examples: Credit comes in many forms—credit cards, home loans, and car loans are common examples of installment credit.

What is Debit?

What it is: Debt is the money you owe a lender after using credit, representing a financial obligation.

Purpose: It arises from borrowing funds to meet a financial need.

How it's created: When you make a purchase on your credit card or take a loan, that borrowed amount becomes debt to be repaid.

Examples: Credit card balances, personal loans, car loans, student loans, and mortgages are all forms of debt.

How Does Credit and Debt Work?

Credit can either be in the form of a credit card or any loan from the bank. A lender provides a decided amount under certain terms once it is approved. The terms and conditions may include interest rates, repayment schedules, and limits.

Here is an example to understand how does a credit work:

Suppose you want to buy a laptop but don't have access to money. This is where you can use a credit card. The bank issues a physical card that you can use while making a purchase. You can either pay the money in full or create an EMI for the remaining account. This remaining amount is known as debt. The lender charges interest on the debt amount until it is repaid.

Debt increases fastly if you have high interest credit cards and loans. Henceforth, you may fall into the debt trap of paying interest against loans.

Tip: Read terms and conditions carefully before taking a credit to avoid financial trouble.

What Is the Difference Between Credit and Debt?

Credit means borrowing money whereas debt is the actual money borrowed. Lenders like banks provide credit cards and loans to an individual who is known as a debtor. Credit usually comes with a certain limit. However, debt increases based on your need and interest.

One can avoid getting into debt if they use their credit wisely. But there is no existence of debt if credit has not been used. For example, you will have credit but no debt if you have a credit card with a limit of Rs. 5 lakhs and haven't used it. You will become a debtor from the moment you spend Rs. 1 lakh from your credit card.

Tip: Prepare a budget for your credit card just like you do for your regular income to stay organized and maintain financial discipline.

What Are the Smart Tips to Manage Credit and Debt?

Now that you know the meaning of credit and debt, it’s important to understand the ways to manage them. Given below are few essential tips to manage credit and debit:

• Credit based on your financial condition
  Treat your credit limit like it's your own money instead of free money to avoid overspending. Make sure that you plan your regular expenses before borrowing a loan to avoid debt trap.

• Pay more than a minimum
  You can prevent yourself from paying hefty bank interests by paying more than a minimum amount. Limited payments keep your account current but can increase your debt for years.

• Avoid Late Payments
  Late payments impact your credit score and often come with fees. So, ensure that you set reminders or use the auto-pay option to stay on track and avoid paying extra from your pocket.

• Limit New Credit Applications
  Having multiple credits lowers your CIBIL score. It states that you are already a debtor and have to make repayments. Thus, ensure that you apply for a credit only when it's necessary.

Wrapping Up!

Credit and debit are two different terms that play an important role in financial management. Credit means the borrowings and debt is the amount borrowed by an individual. Having an understanding of both the terms is crucial for personal finance management. They help individuals in credit management and avoid falling into a debt trap.

Debts are usually passed on to their loved ones in case of the unfortunate demise of the policyholder. So, you can buy a life insurance plan like term insurance to ensure that your family can pay off debt easily without any financial burden.

Note: To compare and choose the best term life insurance plan that aligns with your needs, you can use term insurance calculator.

FAQs