Question

When are we supposed to use the word 'it' and 'that'?

Answer 1

that is used to refer thing that has been said by OTHER PERSON in the previous conversation
example:
A: "I just lost my cat."
B: "That is sad."
---
A: "I got a straight A."
B: "That's awesome!"
that is referring to A's sentence
you can't use it because that will be weird

(btw im not talking about the difference between THAT and THIS, because the explanation will be different)

it is used to refer to our own conversation
example:
A: "I have a pen. It is pretty expensive."
---
B: "I just finished my class. It was boring."
here you can't use that

but in some case, you sure can switch between that and it

semoga membantu! :D