What exactly is credit?

Credit is the ability of a customer to obtain goods or services before they pay, based trust that payment will be made in the future. In today’s world, credit is extremely important- you’ll need credit to rent an apartment, apply for a mortgage, lease a car, get a loan or apply for a credit card.

Having good credit can enable you to qualify for credit cards with lower interest rates and make it easier for you to obtain leases and loans. Conversely, having bad credit can make it difficult and far more expensive for you to handle various aspects of your finances.

There are three major credit reporting agencies in the United States: Experian, Equifax and TransUnion. If you haven’t applied for any form of credit, none of these agencies should have an open file on you. Your file contains information about your credit history. This can include information about your student loan debt, utility bill payments, car insurance payments, and any other open lines of credit you may have (credit cards and bank account activity, for example).

Most lenders use the FICO (developed by Fair, Issac & Company) method to calculate a three-digit number, falling somewhere between 300 and 850, from this information.  Your score is calculated from five different categories, and each is weighted differently. It’s important to understand how your score is calculated so you’re able to improve it or, if you have a good score, keep it that way.

FICO chart

The most important factor in determining your credit score is your payment history. The first thing lenders want to know is whether you’ve paid past credit accounts on time. They’ll look at your payment history on different account types including current credit cards, retail accounts, installment loans, and mortgage loans. Late payments will decrease your score, so it’s important to always make your payments on time.

The amount you owe can affect your credit score as well, even if you make your payments on time. The more debt you have, the more likely it is that you’ll be overextended and will miss or make late payments. Also taken into account is how close you are to “maxing out” a particular line of credit. If you have a high credit utilization ratio, you’re more likely to have trouble making payments in the future.

Your FICO score will consider the different types of credit you utilize. It takes into account your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.

10% of your credit score is determined by the amount of new credit you have. Applying for multiple lines of credit within a short period of time can negatively affect your score, especially if you’ve only recently begun to build your credit.

Order your credit report directly from any of the three credit reporting agencies or an organization authorized by these companies to provide credit reports to consumers.

It’s important to check your credit report yearly to ensure that it is free of any errors, because it is what lenders use to determine your score. You’ll also be able to guard against identity theft if you check your credit report regularly.

You are able to receive a free credit report from each of the three companies once per year by visiting AnnualCreditReport.com. Your report will not include your score.

In order to view your credit score, you may register at creditkarma.com. This is a fairly new and excellent resource to use to monitor your credit score.  It gives you a breakdown of how well you’re doing in several different categories, including the length of your credit history, payment history, credit card utilization, credit inquiries, total accounts, and any derogatory marks appearing on your history.

It also provides recommendations on the cards and different types of loans that may be best for you based on your credit history. It has tools such as calculators to determine interest on a loan or repay your debt, credit and interest rate trends nationwide, and forums with reviews of credit cards, banks and loans.

Monitoring your credit is an important factor in financial health- your credit history and score is the foundation for any financial activities you might undertake in the future. Whether you’re just beginning to build credit, or attempting to recover from poor financial decisions that have negatively affected your credit, staying on top of your credit affairs is key to improving your financial outlook.