By Sam Lipscomb, CEPF®
Credit is one of the most important aspects of a person’s financial life. Your credit score affects your ability to get loans, credit cards, apartments and more. There are several components to credit that have an impact on you and your financial situation. You can check these factors by looking at your credit score and credit report. In this article we’ll discuss the different types of credit, how credit scores work, how you can use the system of credit and more.
To get your credit and overall financial life in order, consider working with a local financial advisor.
What Is Credit?
Credit is the medium through which one’s personal ability to borrow money or access services with the understanding that you’ll pay back any loans or incurred costs is determined. Mortgages, auto loans, credit cards and certain utilities all rely on systems of credit. That’s because a company or organization is providing you with a good or a service in return for repayment and possibly interest.
However, there are other important factors to consider when talking about credit. Your creditworthiness, credit score, credit history and credit report comprise your overall credit profile. Credit is also used to determine interest rates when you borrow money, as those with a stronger credit past receive the best rates.Types of Credit
There are a few different categories of credit, though they all follow the same general premise of using money, a good or a service with the expectation that you’ll pay for it at a later date, often while incurring interest. There are four main types of credit:
When you apply for a loan, credit card or another product that requires a credit check, you credit profile will come into play. The most important factors that affect the state of your profile are your credit score, report and history. Below is an overview of how these credit principles work.Credit Report
Your credit report is the main item lenders will look at when determining your creditworthiness. Each of the three main credit bureaus – TransUnion, Equifax and Experian – have credit reports on file for individuals with any history of using credit. Your credit report includes detailed accounts of all your past and present lines of credit. Your credit utilization ratio, as well as any late payments or bankruptcies, will also show up on your report.
Generally speaking, you’re able to access one free credit report from the trio of credit bureaus every year. However, through April 2021, you can do this on a monthly basis. Your credit report is the most detailed way of looking at your credit profile and determining your probability of success when applying for a new line of credit.Credit Score
The concept of a credit score is one many people become obsessed with. In short, a credit score is a streamlined way of understanding the quality of your credit report. Someone who doesn’t carry high balances on their credit cards, repays their loans on time and hasn’t missed payments or filed for bankruptcies will likely have a higher credit score than someone who has been less responsible with their credit.
Organizations such as the Fair Isaac Corporation, or FICO, use proprietary models to determine your credit score from your credit report and history. While a credit score is a good indicator of your creditworthiness, it’s almost never the sole determinant of acceptance for lenders. FICO credit scores are determined using the grading system below:
FICO credit scores are determined through the use of a scale. The lowest score you can have is 300, while the highest is 850. To make this large range easier to understand, FICO has attributed descriptions for specific areas within it. They go as follows:
Understanding credit is extremely important for your overall financial health. It can help you pay for things on a month-to-month basis, while also making large purchases, like a home or new car, more accessible.
Your credit history, profile, report and score are all important factors when it comes to opening new lines of credit. Without a broad understanding of the factors at play, you could end up paying a higher interest rate or being denied credit altogether. When used properly, credit can help you reach your financial goals.Tips for Building Credit
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