Financial Knowledge Assessment: Q12A

12.  What is the safest initial step that I can take to start building my credit?

• A.  Get a credit card or student loan and pay the bill on time
• B.  Create a credit plan that includes a budget, money set aside for emergencies, and the steps you’ll take to prove to the credit bureaus that you can repay money you borrow.
• C.  Take a cash advance on a credit card and put the money in savings where it will earn interest.
• D.  Borrowing money from family and paying them back overtime at a very low interest rate.

Explanation:  The correct answer is “B.”  Like Question 4, this question deals with the best practices associated with credit cards, which can be very useful if used correctly, and very harmful if not used correctly.  Answer “B” seeks to mitigate the biggest risk with credit cards:  the temptation to spend beyond your means, which can cause of cycle of high-interest debt from which it becomes increasingly difficult to pull out of.  This risk can be mitigated by establishing a budget and having the discipline to stick to it.  It can also be mitigated by saving money for an emergency, which, according to the answer for Question 6, is about 3 to 6 months of pay.  The reason why saving money for an emergency is important is because there is no interest rate associated with using money from your own banking account, whereas the interest on a credit card could be 18% or higher.  Finally, the best means to prove to the credit bureaus that you are capable of paying off your debts is to pay them off on time, which goes back to ensuring that you do not live beyond your means and find yourself in the position of not having enough money at the end of the month to pay down your credit card.

Continue to Question 13