Money Smarts Blog
Crash Course in Credit: The Basics
Jul 6, 2016 || Amanda Spurgeon
You’ve heard people talk about good credit, bad credit, building credit, repairing credit, etc. But unless you have a real understanding of credit itself, you probably don’t know what any of that really means. Asking someone to explain credit can be tough—especially if you already have a student loan or credit card you feel you should know more about.
If you’ve been too afraid to ask about credit, here’s what you should know:
Credit is your ability to get a product or service based on the understanding that payment will be made later. Your credit history tells creditors and lenders how reliable you are to pay it back. The better your credit history, the better your chances are of getting credit.
There are four basic types of credit available:
- Revolving credit is credit that is automatically renewed as debts are paid off, like a credit card. They have a maximum credit limit, and you can make charges up to that limit.
- Installment credit is issued for a set amount, and you make monthly payments (or installments) of a fixed amount over a period of time until the balance is paid in full. Unlike revolving credit, installment credit doesn’t automatically renew after payments are made. Auto loans, mortgages and student loans are examples of installment credit.
- Service credit is any service you receive and pay for with monthly installments—like a cell phone plan, electricity or cable. Not all service accounts are reported on your credit history.
- Charge cards operate similarly to credit cards, but you’re usually required to pay the balance in full each month.
Your credit report is the detailed record of your credit history. These reports are compiled by credit bureaus (more on those later) and used by lenders to determine your creditworthiness. It includes personal information, like your address and social security number, in addition to the number and types of accounts you’ve held in good and bad standing. Any negative information will usually stay on your report for about seven years, while bankruptcy filings usually remain on your report for ten.
There are three major credit reporting bureaus in the United States: Equifax, Experian and TransUnion. All three companies collect information about consumers’ bill paying habits, personal details and accounts to build a unique report. The information in each report will probably be similar, but there are usually some small differences.
Your credit score is created with the data from your credit report. This number is one element lenders use to determine your creditworthiness. Fair Isaac Corp. (FICO) produces the most commonly used credit scoring algorithm in the U.S. Scores typically range from 300 to 850.
So what makes up good credit?
Every lender has different standards for what is considered “good” credit, but scores below 629 are generally considered bad, 690 or above is good and anything over 720 is excellent.
Knowing the basics about credit makes it easier to understand why it’s so important that you use credit wisely—late payments, maxed out cards and bankruptcy all tell potential lenders that you can’t necessarily be trusted to pay them back, making it harder to get credit in the future.
While this is a good place to start, there’s still a lot to know about the credit industry. Stay tuned for our upcoming blog on common credit misconceptions.