What is Credit?

What is Credit?

creditYou might have heard your parents talk about building credit, seen a commercial for credit reports, or possibly discussed it in your finance class. Credit is one of those things that takes a long time to build, but a moment to tear down. It’s something that may never seem important to you until the first time you go to buy a house or take out a sizable loan. Before we discuss how to improve your credit score, we have to first understand credit.

Credit is your ability to obtain goods or services before payment based on the trust that the loan will be repaid in the future. There are different types of credit. For example, credit cards are one form. You are allow to charge a limited amount of money each month with the expectation that you will pay back the credit grantor (credit card company) at the end of each billing cycle. Another popular form of credit is installment credit. This credit includes car loans and home mortgages. The creditor loans you a predetermine amount, and you agree to repay the money with interest in a fixed amount over a set period of time. Sometimes potential employers or potential landlords will check credit scores as a measure of responsibility and risk assessment.

Your credit score is directly linked to the amount of money a creditor will loan you at one time and the percent interest you will pay. If you have a high credit score, your ability to borrow and amount you can borrow increases. Think of your credit score as your financial reputation. A high credit score demonstrates to lenders you are reliable and responsible with your finances. A poor credit score signals a potential risk to lenders.

A credit report is a collection of information about your financial history including: loans you’ve used in the past seven years (even if you have paid them off), loans you currently are using, money you’ve borrowed, your required minimum monthly payments, your payment history (late payments or always on-time), public records (bankruptcy and foreclosures), and any loans you’ve defaulted on. You can gain access to your credit report through your bank or a credit reporting company like Experian or Credit Karma.

A credit score ranges from 300 (poor) to 850 (excellent). The score is calculated by factoring the items in your credit report into a single number. There’s no set score for good and bad; however, potential lenders see scores above 720 as ideal and scores below 600 as problematic.

It takes a while to build a history of good credit, but there are ways you can start to lay the foundation for good credit. These include:

  • Monitor your credit utilization (the percentage of available credit used during a billing cycle). Try to keep your usage under 30% of your available limit. For example, if you have two credit cards, each with a $1,000 limit, you should keep your total spending below $600 ($2000 x .30 = $600) per billing cycle. If you use more, make a payment before the end of the billing cycle.
  • Pay your bills on time! One late payment could drastically hinder your credit score. Set reminders on your phone’s calendar if you have a tendency to lose track of time or set up autopay.
  • Review your credit report and dispute any errors you find with a credit-reporting agency. Periodically reviewing your credit report will also let you know if someone has committed fraudulent charges in your name.
  • Don’t close unused accounts because the length of your credit history matters. When you close a card or account, your history with the account ends; thereby, ending your historical reputation attached with the account.
  • Increase your line of credit. This may mean opening a new credit card or applying to increase your limit. This doesn’t mean you should spend more; it simply means you have a higher credit available to your name. Application to increase credit lines or open an account should be done sparingly. Do not apply for four new cards in the span of a couple months. This could be a negative signal to lenders.
  • Always, always, always pay off your credit cards each month. If you find yourself in debt, readjust your lifestyle and try finding ways to save money. Start paying off debt as soon as possible.

 

Skills

Posted on

November 15, 2016

Positive SSL