Credit is part of your financial power. It helps you to get the things you need now, like a loan for a car or a credit card, based on your promise to pay later. Working to improve your credit helps ensure you’ll qualify for loans when you need them.
What is Credit?
Types of Credit
There are many types of credit. The two most common types are installment loans and revolving credit.
Installment Loans are a set amount of money loaned to you to use for a specific purpose.
Common Examples of Installment Loans
- Student loans
- Auto loans
Revolving Credit is a line of credit you can keep using after paying it off. You can make purchases with it as long as the balance stays under the credit limit, which can change over time. Credit cards are the most common type of revolving credit.
Not all credit cards are the same. Make sure you explore all pros and cons of credit cards when choosing the right one for you.
Interest is a cost of borrowing money. Lenders generally charge a certain percentage of the average daily balance of your account, which is called an interest rate. This interest rate is applied to your outstanding balance on a monthly basis. Credit cards may have different interest rates for different types of activities, like purchases or cash advances, so make sure you read the fine print.
Many credit cards charge fees, but not all cards charge the same fees. Take care to fully understand what fees you are responsible for.
Your credit limit is the maximum balance you can have on your credit card. It is determined by your lender, based on your credit history and income.
Credit Origins: Reports and FICO Scores
Your credit report is what the nationwide consumer reporting agencies use to calculate your credit score, which is used by lenders to determine your credit worthiness. The three major nationwide consumer reporting agencies are Equifax, TransUnion, and Experian.
What is a FICO Score?
Credit reports are used to generate a credit score. One of the most commonly used credit scoring formulas is Fair Isaac’s FICO score, which ranges from 300 (low) to 850 (high). The higher your score, the more likely you are to be approved for new credit, or offered a lower interest rate. Many factors from your credit history are used to calculate your FICO score. The nationwide consumer credit agencies don’t disclose how scores are calculated, so no one knows exactly how they are determined. The agencies may have different data on your credit history, so your score can vary between the agencies.
Your credit report shows your payment history (on time, late, or missed) for the past seven years.
Hard Inquiries vs. Soft Inquiries
Every time a potential creditor accesses your credit report and score, it’s recorded on your report as a hard inquiry. Too many of these can show potential creditors that you are attempting to open more than one line of credit and they may choose not to loan you money.
You might also hear about soft inquiries. They occur when your credit report is reviewed when you’re not looking to open new credit lines. Unlike hard inquiries, soft inquiries aren’t considered by lenders when evaluating whether or not to loan you money.
Examples of Soft Inquiries
- Landlords run credit checks when you apply to rent property
- You accessing your own credit report for monitoring
Your Superpower: Good Credit
Many aspects of life are affected by credit ratings. They may:
- Determine whether a lender approves a new loan.
- Influence your interest rates and fees on the loan.
- Be reviewed by employers before they offer you a new job.
- Be used by landlords when deciding whether to rent to you.
- Determine your student loan eligibility, including most private loans.
- Be reviewed by insurance companies when you apply for many types of insurance, including car or homeowners insurance.
Good Credit vs. Bad Credit
Having good credit means that you are making regular payments on time, on each of your accounts, until your balance is paid in full. Alternately, bad credit means you have had a hard time holding up your end of the bargain; you may not have paid the full minimum payments or not made payments on time.