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.
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.
Building credit is basically the process of building a history of reliable on time payments. Some ways can include:
Credit history, credit report and credit score all play a role in determining your credit.
This is the full collection of all your borrowing, spending and payment history. It is made up of:
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.
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.
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:
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.
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.
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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