Credit 101: Credit Basics You Need to Know
Question of the day on Instagram: What is credit and why is it important? Let’s talk credit basics! I’m here to give you a “credit 101 rundown” in easy to understand terms with relatable examples!
The Credit Basics
What exactly is credit and why is it important?
Well, first things first: credit is the ability to borrow money now and pay it back later.
Why is it important? From a basic perspective, having a good credit history gives you more options. If you have good credit (meaning you have a good track record of borrowing & paying back), it’s easier to borrow more money in the future.
Common Types of Credit
The most common types of credit are credit cards, homes, cars & student loans.
To access one of these types of credit, you have to apply for it. The amount you’re authorized for is going to be determined by the lending institution (like banks) based on your financial history.
If you have good credit, it’s easier to apply for more credit. Which comes in handy when you go to rent an apartment, buy a car, buy a home or get a loan.
Having good credit helps you save money on interest. If you need a refresh on interest & interest rates, head to this post! Good credit will help you get lower interest rates and reduced or waived fees.
Installment Loans and Revolving Credit are the most common types of credit.
With an Installment loan, you borrow a specific amount of money for a specific use. Then you pay it back with monthly payments (including interest). An example of an installment loan would be a home mortgage.
Revolving credit is how credit cards work: you get a line of credit up to a certain limit. You can borrow money as needed and pay it off over time or all at once.
Good Credit vs. Bad Credit
When someone says good or bad when referring to credit, they’re talking about your “credit reputation”. Or your history of borrowing and paying back what you owe.
Simplified: If you make regular, on time payments, you will have “good credit”. If you have a lot of missed and late payments, you will have “bad credit”. You can fix this & build your credit by continuing to borrow & pay back money.
How Can I Improve My Credit?
There are a lot of different ways to improve, or boost your credit. A few examples:
- Pay your bills on time
- Don’t max out a credit card
- Keep your credit balances low
- Only apply for credit when you need it
What is My Credit?
There are a few factors that involved in your credit: credit history, credit report & credit score.
Your credit history is that history of borrowing, spending & paying back. This includes your payment history, closed accounts, open accounts & amount of debt you owe.
A credit report shows is kind of like a credit report card. The report is pulled before you are given a loan or an increase is made in your credit limit. Think of it as a way for lenders to decide whether or not they trust you.
The credit score is a number. It will range from 300-850, grading your creditworthiness. The higher the number, the better.
What’s so Important about Credit?
Well, it is kind of the gateway into financial decisions because it will determine if and how much you have access to.
If you plan on buying a car or even a home, you’ll most likely look into getting a loan. Your credit will play a role in whether or not you’re approved for a loan and what interest rate you’ll pay. Simply put, it opens up more opportunities.
Where Should I Start?
If you’re starting from scratch (or even if you just want to improve your credit), there are a few strategies you can look into:
- If you’re not ready to get your own credit card, you can become an authorized user on a family member’s account. If they have good credit & link your name to it, you can benefit from their work without having to make any payments of your own.
- If you’re not eligible for a credit card, look into secured cards. They’ll require you place a deposit which serves as a safety net for the lender. Meaning, if they’re worried you won’t pay back your debt, they have a the deposit as a buffer. As long as you pay your balance on time, that money is safe.
- Make payments on time & always make at least the minimum payments.
- Don’t over utilize credit – you’ll want to make sure that you’re using less than 30% of it. A good goal is to keep it under 10%.
- Keep your credit accounts open, even if they don’t have a balance. When your credit history is calculated, your average account age is taken into consideration. Meaning, they appreciate long term credit relationships!
If you’re looking for a little more help, I recommend checking out the credit pros. They offer easy to read and understand credit reports & personalized insights. Plus, tools & tips to help you understand and improve your score. You can also get your credit score for free using this link.
Credit Basics: Misconceptions
- Misconception: Credit cards mean free money.
- Explanation: Some people think that when they use a credit card, they’re using money that they don’t have to pay back. In reality, when you make a purchase with a credit card, you’re borrowing money from the credit card company. You need to pay it back, often with interest, by the due date. It’s not free money; it’s a loan.
- Misconception: Checking your credit score frequently hurts it.
- Explanation: Checking your own credit score is known as a “soft inquiry,” and it doesn’t affect your credit score. However, some believe that if they check it often, it will go down. This is not true. It’s essential to monitor your credit score regularly to stay informed about your financial health and catch any errors, and it won’t harm your score.
- Misconception: Closing a credit card improves your credit score.
- Explanation: Closing a credit card can actually have a negative impact on your credit score. Part of your credit score depends on the length of your credit history and the total amount of credit available to you. If you close a credit card, it may reduce your available credit and shorten your credit history, potentially lowering your credit score. It’s often better to keep the credit card open, even if you’re not using it regularly.
