Credit is the ability to borrow money or access goods or services with the understanding that you’ll pay later. Unless you pay cash, you’ll need credit for most of your major purchases.
How Does Credit Work?
Credit can provide security, convenience, and even reward you based on spending. However, if you don’t manage your credit carefully, you may find yourself facing unwanted consequences like a poor credit score or hidden fees.
A lender or merchant will provided credit based on their confidence that you can be trusted enough to pay back what was borrowed plus any finance charges that may accrue, like interest.
Credit providers used to work off of minimal information in the past and it was much harder to get credit even just 10-15 years ago. Today, your credit history is digitally summarized into credit reports compiled by the three major credit bureaus: Experian, TransUnion and Equifax.
Whenever you have a line of credit the bank, credit union, credit card issuers or other lending services will report back to the credit bureaus about your timely and untimely payments. This credit report and your credit activity help build your credit score. A lender will use your credit score as a quick way to make a decision on if you are creditworthy.
Types of Credit
There are four types of credit:
- Revolving credit: If you’re given revolving credit you will be given a maximum borrowing limit that you can’t exceed. You can charge up to that limit and must make the minimum payment each month. A common example of revolving credit is a credit card.
- Charge cards: These are commonly issued by retailers for use exclusively in their store or online shop. These are used in the same way was credit cards but you must pay in all charges at the end of the month.
- Service credit: This is a contract you have with utility companies like natural gas or electric. All of these are credit agreements and they do report to the credit agencies with modern credit scoring systems.
- Installment credit: This is a loan for a specific sum of money that you agree to repay with interest. These can be student loans, car loans or even a mortgage.
Guides to Building and Managing Credit
Understanding what a credit score is and what it is used for is vital to managing your credit. The higher your credit score the financial doors open for you. A low credit score could mean the difference between owning a home or car and not.
Learn the fundamentals to building credit with our step by step guide to building credit. This caters to users with zero credit but can be used by everyone, especially if your credit is suffering. You’ll want to start building credit at a young age to get the most out of it later on in life.
A credit card is how most people start building credit. Learn everything there is to know about credit cards. Not sure which ones are right for you? Take a look at our ultimate guide to credit cards to make sure you’re making the right choice before you go into debt.