Understanding Credit: A Beginner’s Guide

Credit is an essential part of your financial health and planning. A solid understanding of credit helps you make more informed decisions when taking out a loan or applying for a new credit card. It’s equally important to know how to manage your credit debt so you can identify areas that need improvement and increase your overall credit score. Building your credit history along with a good credit score is essential if you ever plan on taking out a loan or leasing an apartment. Educating yourself on the world of credit also helps you avoid scams that negatively affect your score. If you want to learn how credit affects your finances, we got you covered. Keep reading to learn more about the world of credit. 

Good credit vs Bad credit 

While the world of credit scores might seem like a foreign concept, you likely know if you have a good or bad credit score. Good credit is a score considered favorable by lenders and other financial institutions. Typically, a good credit score is 700 or above on the FICO credit score scale, which ranges from 300 to 850. Lenders consider a favorable credit score as a sign you are a low-risk applicant. Good credit increases the likelihood of getting approval on mortgage loans, credit card applications, and more. In addition to better chances of getting approved for a loan, good credit may earn you more favorable terms on your loans or credit cards and lower interest rates on your owed amount.

On the other hand, poor or bad credit refers to a score considered unfavorable by financial lenders. A bad credit score is from 300 to 550 on the FICO scale. Lenders consider individuals with poor credit as high-risk borrowers. Lenders are more likely to reject loan applications from applicants with poor credit. When you get approved for a loan or credit card with a bad credit score, expect less favorable terms and higher interest rate costs.

Factors that affect your credit score

Several factors can affect your credit score, some lowering your credit and others increasing it. Payment history plays a significant role in your credit score, including whether you have made a late payment or have any delinquencies or loan defaults. In addition to your payment history, your credit history is another factor that affects your overall score. Lenders and financial institutions consider the length of your credit history and the types of credit you have. A long credit history with a healthy mix of different kinds of credit like a mortgage, hard money loans, credit cards, and student loans are viewed positively if you carry the financial weight of each account. 

Another factor to consider affecting your credit score is your credit utilization. This means the amount of credit you’re using (debts you have) compared to your overall credit limit. High credit usage may indicate you’re a little in over your head in terms of your loans, meaning you may be more likely to miss a payment. Relevant to your credit utilization is credit inquiries. Hard inquiries occur every time you apply for some form of credit, and each time affects your credit score. Too many hard inquiries in a short period is a red flag for financial institutions because it shows you may be a little in over your head in terms of finances.

Reading your credit report 

Your credit report offers a summary of your credit history and should include your credit and loan accounts. To obtain your credit report, you get a free copy once a year through major credit bureaus like Equifax and Experian. While these reports offer you a detailed view and should be utilized, aim to check your credit more frequently. Many banking institutions allow you to review your credit through their apps or by requesting it through customer service. These views of your credit score may not be as detailed, but the information should be accurate so long as your credit history is up to date. 

When reviewing your credit report, always ensure that all your information is correct. This includes your name, address, and social security number. You should also double-check that all your different credit accounts are accurate and without error. This includes accounts you didn’t open or issues with your credit that don’t make sense based on your account activity. 

Your credit report will also include your payment history, including any late or missed payments, and derogatory marks such as bankruptcies, foreclosures, and debt collections. These may impact your overall credit score depending on how much time has passed. Your credit score on your report will be a three-digit number and impacts your eligibility for receiving credit in the future, in addition to your ability to lease an apartment. This is why you must regularly track your credit to check for suspicious activity or errors. 

If you do find any errors in your report, dispute them as soon as possible. To report any errors on your credit report, contact your credit bureau so they can investigate and correct them if necessary. 

The different types of credit 

Now that you know a little more about your credit report, it’s time to learn about the different types of credit. There are quite a few types, all with slight variations and particular qualities. 

  • Revolving Credit: Credit cards offer this type of credit, which enables you to borrow up to your credit limit and make payments over time. Making your payments on time allows you to borrow against your credit limit. 
  • Charge card: Unlike credit cards, this type of credit requires the borrower to pay off the entire balance each month instead of making a minimum payment. For example, say you spend $400 using your charge card, you’ll have to pay the amount in full at the end of your credit period. 
  • Student loans: Student loans are credit to finance a college education. Post-education completion, you will need to pay back your loan. Many student loans offer payment plans to help pay back your loan after completing your education, which can help minimize the threat to your credit score. 
  • Installment credit: This kind of loan requires the borrower to make fixed payments over a defined period. You must pay it off in full at the end of your term for this loan. An example of installment credit is a car or personal loan. 
  • Secured credit: When applying for this type of loan, you use your car or home as collateral. You may see this kind of credit as a secured credit card. 
  • Unsecured credit: Unlike secured credit, unsecured credit does not have collateral as a guarantee.
  • Mortgage: You can use mortgage credit to purchase a property. For this type of loan, you pay back the amount over a 15-30 year period and the property you purchased is used as collateral. 
  • Business loans: You can use this type of credit to finance your business operations or expansion. Business loans have to be paid off over a defined period. 

Each kind of credit option will have its unique terms and stipulations, so you must read the fine print and have a solid understanding of what you’re getting yourself into. Having a mix of different kinds of credit and loans shows financial institutions that you’re a safe borrower, improving your chances of being able to apply for more credit in the future, so long as you make your payments and properly back your lender. 

Getting a grip on your credit score

Credit affects a lot of things, from our ability to open new lines of credit for a mortgage or new credit card, as well as our ability to apply to rent an apartment. Improving your credit history and score is easier the sooner you start. Now that you know a little more about the world of credit, you’re on the right track to financial security and health. 

Author Bio:

Megan Isola holds a Bachelor of Science in Hospitality and a minor in Business Marketing from Cal State University Chico. She enjoys going to concerts, trying new restaurants, and hanging out with friends.

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