When you begin managing your finances, you learn pretty quickly that credit is important – but what is it? Credit is the shorthand name for the agreement you enter when you purchase or receive something and then pay for it later. Creditworthiness refers to the likelihood that you’ll pay for those things responsibly over time.
A person with “good credit” typically has a history of making on-time monthly payments towards items purchased using credit, whereas a person with “bad credit” has a less reliable record of paying accounts by their due date. If you’re in the bad credit group, you’re not alone. About 16% of people in the US have substantial inconsistencies in their histories, or very poor credit, and another 18% have “fair” credit.
Major Types of Credit
For the purpose of this article, there are two major types of credit afforded to borrowers in the lending industry: revolving credit and installment loans.
Revolving Credit
With revolving credit, you are provided with a maximum borrowing limit, also known as credit line, which you can use to pay for goods and services up to the credit limit. You will typically be sent a billing statement each month with a minimum amount due that you should pay by the due date. Any outstanding balance not paid will be charged interest. A credit card and home equity line of credit are examples of revolving credit lines.
Installment Loans
An installment loan is money that a lender provides to borrowers for a set amount, which is expected be repaid by a certain date, typically via monthly payments over several years. Student loans, personal loans, auto loans and home mortgages are all types of installment loans.
Who Keeps Track of Consumer Credit Usage and Why?
The three major credit tracking agencies, Experian, Equifax, and TransUnion, are called credit bureaus, and they keep track of consumer credit usage and repayment of accounts. If you’ve ever applied for an auto loan, credit card, or home mortgage, you should have an established a credit history.
That history is detailed in your credit report with each agency. Whenever you apply for a loan, line-of-credit, or credit card, the creditor checks your credit report to see your history and associated credit score.
Using the payment information on the report, the bank, credit union, or other institution will decide if it wants to lend to you and the terms it would like to offer. If you want the best terms the lender has to offer, you need to have excellent credit. Therefore, you want to maintain good credit habits.
There are lenders who work with people who have lower scores too, but they’ll charge more interest, and offers less funds to minimize their risk of losing money.
What’s a credit score?
Based on information derived from a credit report, consumers are assigned a 3-digit number that represents their creditworthiness according to the credit scoring model being used. That number is your credit score and works as shorthand to give lenders a quick glimpse into your history without having to dive deep into your credit file.
A credit score typically ranges from 300 to 850, is calculated using a scoring a model provide by either FICO or VantageScore, and is generally categorized as follows:
300-600: Poor
600-675: Fair
675-750: Good
750-800: Very Good
800-850: Excellent
The actual number range varies depending on the exact model being used by the company providing the score to you, but this gives you a good idea of the range most commonly used.
When you have a credit score in the Very Good or Excellent range, you can borrow money at the lowest interest rates and take advantage of better rewards programs. Some benefits may not be offered to consumers in the lower credit score ranges.
Credit scores and reports aren’t just used to calculate the financial risk with lending money. There are lots of people who might check credit to enter into another type of financial agreement with you. That could include a landlord, utility company, government agency, or even a potential employer. For these reasons, having good credit is a must.
How can you raise a credit score?
Almost half of consumers fall into the Poor and Fair credit score groups. If that is you and you’d like to make some improvements to your score, great! There are lots of things you can do, but it’s first important to know it is going to take time.
The first step is to understand your debt. Pull everything together and create a clear picture of what you really owe. Student loans, medical bills, credit card debt, and cash owed to family are all debt. Once you understand what you’re working with, you’ll be able to create a plan.
Debt consolidation is sometimes a solution, and so is refinancing or personal loans. Credit counselors and management firms may also be able to take control of your situation and work on your behalf to lower your rates and obligations. Under the most extreme circumstances, a bankruptcy attorney may be of help to you.
But the best way overall way to maintain a good credit score is to always make your payments by the due date, even if it’s just the minimum amount due, and try not to use up too much of your available revolving credit lines.
