From how you spend to how you save - your overall financial picture is made up of countless details. Two of the most important? Credit and debt. How you manage both can have a big impact on your financial future. Understanding how to use credit wisely while managing debt responsibly is essential for building long-term financial health.
Read more: How an Ally Bank Spending Account can simplify your finances
What is the difference between credit and debt?
Credit and debt are closely related but distinctly different: credit is your borrowing ability and debt is what you owe. This table provides an overview of the difference between credit and debt:
Type | Definition | What the Amount Represents | When it occurs |
|---|---|---|---|
Credit | A privilege or ability to borrow | The amount you have access to | Precedes the borrowing (before you use it) |
Debt | An obligation to repay | The amount you owe | Occurs after you use credit (after you borrow) |
What is credit?
In general, credit refers to the ability to borrow money with the understanding you'll pay it back later, often with interest. Credit is a tool to help you pay for the things you want and need, but it’s important to manage the resulting debt responsibly.
Credit and debt are closely related but distinctly different: credit is your borrowing ability and debt is what you owe.
How does credit work?
In some ways, credit is similar to a loan. A lender — like a bank or credit card company — approves a borrower for a certain amount of money. The borrower must pay back the money to the lender according to the terms of the loan, which usually includes interest.
Types of credit
Credit can fall into one of many different categories, but the two most common are installment and revolving.
Installment credit
Mortgage, car, student and personal loans are all considered installment forms of credit. This type of credit is typically paid back on a fixed schedule (usually monthly) with the same amount of money due at each interval.
Revolving credit
Credit cards, home equity lines of credit, personal lines of credit and business lines of credit are all considered forms of revolving credit. This type of credit is open-ended, and you can keep using it and paying it down as much as you want as long as the account remains open and in good standing.
Revolving credit usually has a maximum limit you can borrow. When you make a charge or use the money, the total balance available to you decreases. Every time you make a payment, your total available or utilizable credit will increase again.
What is debt?
When you borrow money that you need to pay back, that’s a debt.
Good vs. bad debt
All forms of debt are not created equal. Some debt comes with assets that can appreciate in value over time. A mortgage loan is a good example. Ideally, once you’ve paid off your mortgage, you now have an asset that's worth more than you spent on it. If or when you choose to sell your home, you could end up with a profit. Student loans and business loans are other types of debt that could help you achieve a goal now that will result in future financial gain.
However, some debt (like credit card debt) is not seen as favorable. When you rack up credit card debt, it's not an investment. You'll have to pay it back — plus interest — and credit cards typically come with much higher interest rates than those on student loans or mortgages. And unlike those types of debt, there's no home or career at the end to make it all worthwhile.
Types of debt
Two common types of debt are secured and unsecured.
Secured debt
Mortgages, auto loans and secured credit cards are all considered secured debt, or a loan backed by collateral. This type of debt reduces risk for lenders because if the borrower defaults, the lender has a legal right to seize or foreclose on the asset to recoup their money.
Unsecured debt
Unlike secured debt, unsecured debt is a loan or financial obligation not backed by collateral. Common examples include credit cards, medical bills and student loans. Lenders approve these based on creditworthiness, often resulting in higher interest rates due to increased risk.
How to manage debt and credit
Credit is a financial tool to help you pay for the things you want and need, but it's important to manage the resulting debt responsibly. To keep your debt under control and strengthen your credit score, aim to make on-time payments. You can set up Ally Bank’s spending and savings buckets to track payments and recurring bills.
Check your credit report often so you can make changes if you need to. Don't take on more debt than you can reasonably afford, and whenever possible, make more than the minimum payment.
Tip: Use our free credit card calculator to map out your payment plan.
Boost your financial future
By getting smart about debt and credit and how to manage both effectively, you can make sure your money choices today pay off for the many tomorrows ahead.
