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What is Credit?

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Credit is tricky and hard to understand. Read this blog to get an in-depth explanation of credit scores and how you can determine yours. 


What is credit?

Okay, okay. You’re looking to find an explanation on what credit is because you need to buy a car, house, apartment, or any big/important financial decisions. Understanding credit is something we all need to do, it’s famously inevitable. So what is credit? 


Credit is the ability to be loaned money/goods or services in the sense that you will pay it back later. Service providers, merchants, lenders, and other businesses grant you credit based on your history of payments and whether you paid back whatever you borrowed. If you are “creditworthy,” or worthy of their trust, you are said to have good credit. 


How does credit work?

Creditors take a look at your credit history, which is your record of borrowing and repaying your loans. Your credit history is organized and summed down into files called ‘credit reports.’ This is how they make a decision on whether to give you credit. This credit report is made by three credit companies: TransUnion, Experian, and Equifax. Banks, credit unions, credit card companies, etc., all give information to these three companies so that they can compile your credit report. 


Your credit report has information in it such as the following:

  • How many credit cards you have as well as how much you can withdrawal/borrow and your outstanding balances (the remaining debt you owe).

  • The number of loans you’ve taken out and how much you’ve paid back.

  • Whether you paid your bills on time, late, or if you’ve missed them. 

  • Really big financial setbacks such as repossessions (when your loans are taken back, such as your house, car, land, or personal property), foreclosures on your mortgage (when your mortgage servicer will take your home, which is the collateral that secured the loan), and bankruptcies.


When they analyze your history, they estimate your credit by giving it a 3 digit score. Your credit score is a representation of your credit history. This way it’s easier to interpret and understand. Credit scoring models calculate your credit score by analyzing the information on your credit report. Credit scoring models like FICO Score and VantageScore calculate your credit scores differently. They give higher scores to people who are more statistically creditworthy. 


Are there different types of credit?

Yes! There are four types. 

  • With revolving credit, you’re given a maximum borrowing limit. You can make charges/withdrawals up to this limit. You have to pay a minimum payment every month, or the amount that you pay can be a part of your outstanding charges up to the full thing. If you make a little payment, you can carry on with the remainder of your balance, or revolve the debt. 

  • Charge cards are rare. They’re much like credit, but they don’t force you to carry a balance. You have to pay back all the charges fully every month. 

  • Service credit is your contract with your providers such as gas or electric, cable or internet, cellular phone companies, gym memberships, etc. They’re all credit agreements. They give you these services in exchange for payments after. Credit scoring systems like FICO Score or VantageScore can include your service payments into your credit score, but they’re not always reported to the credit bureaus. The Experian Boost program allows you to share your utility and cellphone payments so they can boost your credit scores based on Experian data. 

  • Installment credit is a loan for an exact amount of money that you have to pay back. Repaying this loan may include interest and fees. You have to pay equal payments each month over a period of time. These payments are called installments. Car and student loans are some examples of installment credit.


Why do we need good credit?

You need good credit for big financial purchases such as buying a car or a house. Higher credit scores mean better interest rates and terms on credit cards or loans. Most credit card companies save better deals for people with higher scores. Here are some other people/businesses that also take a look at your credit:

  • Landlords

  • Insurance companies

  • Utility companies

  • Employers

  • Reasons including identification and laws

It’s important to check if you have good credit and to know how to fix it if you don’t. Sign up for Credit Karma to check your credit score today. We hope this blog broke down the basics of credit! Team, signing off! 


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