Credit 101: Everything You Need To Know

You probably already know that credit is an important part of building a strong financial future. From funding college to making important purchases like a car or a home, credit is an essential part of living your best life and achieving your long term goals. Why is this three digital number – your credit score so important? And how does it really work? We’ve got you covered. Read on to learn more and quickly get up to speed.

What is credit? 

Credit is the ability to borrow money and pay it back. It’s the relationship between the consumer (borrower) and usually a bank or financial institution (lender). In order to extend credit to someone you need to both trust them, and have confidence that they have the means and ability to pay you back. That’s where credit scores and income checks come in. 

How does credit work? 

When you buy something with credit, you’re essentially purchasing it now with the promise to pay later. When someone has “good credit” it means they have a history/reputation of keeping their promises– this leads to more people trusting them and access to more/better credit. By converse “bad credit” is when they have some missed payments or missed promises which makes it harder to access credit in the future.

What does building credit mean? 

Building credit is basically the process of building a history of reliable on time payments. Some ways can include: 

  • Paying bills on time (like phone or internet bills)
  • Making loan payments on time 
  • Being responsible in not maxing out credit cards and keeping balances low
  • Applying for credit only when you need it (hard credit checks can hurt your credit!)
  • Investing in building a strong credit history, and starting early

How is credit determined? 

Credit history, credit report and credit score all play a role in determining your credit. 

Credit history:

This is the full collection of all your borrowing, spending and payment history. It is made up of: 

  1. All the credit accounts you have opened or closed
  2. How much is owed on each account
  3. Payment history including amounts and timelines

Credit report:

This is basically a record of your credit history. It documents how you have accessed and managed credit and is something future lenders can review to determine how reliable you are and whether to extend credit and on what terms. These are typically generated from one of three credit bureaus– Exuifax, TransUnion and Experian. They include some personal information, info about your credit accounts, and also past inquiries. Inquiries can be hard or soft credit checks. Soft inquiries do not affect your credit score. Hard inquiries can damage your score and you want to have as few as possible. 

Credit score:

This is a three figure score from 300-850 that shows your creditworthiness. It works like a grade on how trustworthy you are with credit. Higher is better. 

How is a credit score calculated? 

Every time you access (or apply for) credit it gets reported and tracked by a credit bureau (basically a company that tracks this history). Credit scores (also called FICO scores) are calculated using many different pieces of credit data in your file/report. The data is grouped into five categories: 

  • Payment history (35%) 
  • Amounts owed (30%) 
  • Length of credit history (15%) 
  • New credit (10%)
  • Credit Mix (10%)
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Your credit score considers both positive and negative information in your file. The percentables reflect how imp[ortant each of the categories is when it comes to determining how the score is calculated. The importance of these categories can vary across people and over time. This article has a good breakdown of each category. 

Your score evolves frequently. So it’s not possible to measure the exact impact of a single factor without looking at the entire report. The key thing is to start building a positive history. 

Why is Credit Important? 

Credit is a critical part of achieving your financial goals. It can be the difference between being able to get student loans or not, being able to start a business in the future, and being able to buy a car or a home. In some cases it is also necessary to rent a home, and qualify for certain jobs. When you do get a loan it also determines the interest rate. With a better score you can save tens of thousands on interest over the course of your life. 

Having a good score really pays off in the long run and opens up opportunities that may otherwise be out of reach. 

Credit 101 FAQs

  • Why is credit so important? It determines whether or not you can access money to achieve your goals– paying for school, buying a car, buying a home, or paying for emergency expenses. It also determines interest rates which can have a huge impact on your long term financial success. 
  • Does credit matter if you don’t need to borrow money? It can make it easier to rent an apartment, qualify for better cell phone/internet pricing, and qualify for certain jobs. Someday you will want to buy a car or a home, and it pays off to start early cause it takes time to build a strong credit history. 
  • How can I start building credit? The most common way is to get a credit card but approval rates can be low for your first credit card, it results in a negative hard inquiry, and it comes with high interest rates. For many, a better option would be something like the Atlas card– it builds credit with daily transactions, prevents over spending, and ensures you never pay any interest. 
  • How does someone get a good credit score? It helps to start early. In fact its never too early to get started. Choose a product with auto-pay to ensure you never miss a payment. And ideally pay off your entire balance every month so you have low utilization– this shows that you can manage credit responsibly. Small changes and consistency can have a large impact in the long run. 

Bottom Line

It takes time to build credit and there are many factors to consider. By starting early with low risk you set yourself up for a brighter future and a stronger position to achieve your long term personal and financial goals.

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