Credit, including your credit report and credit score, is one of the most important pieces of personal financial information that will stay with you for the rest of your life.
While credit—which refers both to your ability to borrow money and your financial reputation—can be incredibly beneficial and can help you buy things that you need, it can also be extremely harmful if not properly managed.
“The first thing people need to realize is how impactful their responsible use of credit is in so many different aspects of their life,” says Fred Elsberry, president of the Better Business Bureau in the metro Atlanta region.
When you borrow money to buy something today, and then pay for it later, you are using credit. Taking out a loan for buying a car, mortgaging a house, borrowing from the bank to start a business, using government loans to pay for school and even buying gas and groceries with a credit card are all examples of purchases made with credit.
When a creditor agrees to lend you money, you are required to repay it over a certain length of time, usually by a specific date, with interest and any other fees set by the lender—a process called loan repayment. Interest is the additional money owed to the lender as compensation for loaning money, and the total amount of money owed is called debt.
While the terms of repayment may vary depending on the loan, the basic concepts of credit and debt stay the same: Borrow now, pay later.
The three main types of credit include:
Revolving credit: With revolving credit, you can repeatedly borrow up to a pre-established maximum limit, as long as you regularly pay off at least a portion of what was borrowed. There are no set payment amounts with revolving credit. Instead, the borrowed amount is either regularly paid in full, or partial payments are scheduled and the borrower agrees to pay interest and fees on the balance. A credit card is the most common type of revolving credit.
Installment credit: With installment credit, you pay back the loan, plus interest, using regular payments of predetermined amounts. Examples of installment credit include car and mortgage payments, where you pay the same amount each month until the loan and interest have been repaid.
Open credit: Open credit must be repaid in full every month.
What are my credit report and credit score, and how are they used?
A credit report is a complete history of all your credit experiences, and generally includes the following information:
- A list of how many credit accounts you have, who they are with and how old they are;
- How much debt, if any, is outstanding on the accounts;
- Your payment behavior, including your payment habits: on time, late or not at all;
- If any collection actions have been taken against you;
- If you have filed for bankruptcy;
- If you have been sued or arrested.
A credit score is a three-digit number that is based on your credit history. Creditors use it to predict how likely you are to repay your debt and make payments when they are due. Potential lenders use your credit report and credit score to assess how trustworthy, or creditworthy, you are and to decide if they want to extend you credit. Creditors will also use your credit report and credit score to determine your repayment terms and interest rates.
“It’s never too soon to begin to establish a very good credit history, which will give you a good credit score, and will impact many areas of your life that you can’t foresee now,” Elsberry says.