What is Credit and Why is it Important?

Your credit can play a significant role in your financial future and it’s important that you’re aware of how to improve it.  Your credit worthiness will impact your ability to get an apartment, a car, and loans.  For something so important, credit can be tricky to navigate for beginners especially. What is credit, and why is it so important? Let’s find out.

What is Credit?

Credit refers to your financial standing, specifically in regards to your projected ability to be able to pay money you may borrow back. It’s often referred to with a ranking – “good credit” or “bad credit.” Buying something on credit means that you are using money someone else lends to you to make a purchase with the promise that you will pay them back, plus a little extra. It is no surprise that creditors want to know how trustworthy you are before loaning money out, so they check your credit.

Credit is used by financial institutions to determine whether or not they will loan someone money, credit card companies use it to approve or deny applications, and many landlords look at credit before accepting rental applications. Some jobs even take your credit into consideration before extending a job offer.

Credit Reports and Credit Scores

When a creditor checks your credit, they are likely looking at your credit report and/or your credit score. Your credit score is a number that quickly gives creditors an idea about your financial situation and projected ability to pay them back. A credit report is a more in depth look. Creditors will often use your credit report to determine whether or not they will be able to extend a credit offer to you, as well as what the terms of that offer will be. A lower credit score means that lending you money is riskier for the creditor than it would be to lend to someone with a higher credit score. Because of this, lenders may charge a higher interest rate or be stricter in regards to the time period they want the money paid back within.

It’s important to check your credit score regularly, using a reputable source, as it can be one of your first indicators of identity theft. If you notice something on your credit score or credit report that you don’t recognize, check into it as soon as possible. You are entitled to one free credit report each year from the three main consumer reporting companies – TransUnion, Equifax, and Experian. Take advantage of your free access to your credit report each year so you know where you stand financially and can check for activity you don’t recognize. You can check your credit score for free on a more regular basis. In fact, it’s not a bad idea to check it monthly.

TIP: Get a free copy of your credit report from AnnualCreditReport.com

Measuring Credit

Your credit score should fall somewhere between 300 and 850, with 300-579 being considered “very poor” and 800-850 considered “exceptional.” If you have absolutely no credit history, it is possible to have a credit score of zero. The average credit score is currently around 695.

Five main factors go into determining your credit score. These factors include your history of making payments, how much of your open credit is being used, how long you’ve had credit accounts open, how many times you have recently applied for new credit accounts, and the variety of credit accounts on your credit history.

Improving Your Credit

It does takes some time to build or improve your credit. It’s unfortunately easier to hurt your credit than improve it, because creditors want to see a pattern of responsible financial behaviors. All it takes is one mistake to ruin that pattern, which can lead to a drop in your credit score that will take some time to repair.

If you’re looking to improve your credit score, consider these tips:

  • Keep balances low on your credit cards. The amount of open credit you are utilizing affects your credit score, so keeping your balances low can help your score increase.
  • Make all your payments on time. Never skip a payment, even if you can only make the minimum.
  • Pay off any collections as soon as possible. While they will still remain on your credit history for some time, the sooner they are paid off the sooner they will eventually go away.
  • If you don’t have any credit, start taking steps to establish a credit history now.

Importance of Having Good Credit

Good credit can make all the difference between getting approved for a mortgage to buy the house of your dreams or not. It can dictate whether you get approved for the auto loan you applied for, as well as what the interest rate on your loan will be. Your credit score can even affect whether or not you are offered a job you applied for or are accepted by a new landlord. Your credit will follow you for the rest of your life, and it’s important that you pay attention to it and take steps towards a good credit score sooner rather than later. Having good credit can save you money over time as you are more likely to be offered lower interest rates and better terms when you apply for credit accounts. You are also more likely to be approved to open rewards credit cards, which can provide perks that save you money over time as well.

Skipping a payment here or there, or racking up unnecessary credit card debt, may not seem like that big of a deal now, but it can come back to haunt you in the future. Your financial decisions now will have a direct impact on your future financial decisions, such as when you want to buy a house, start a small business, or get an auto loan. Remember that it takes some time and concentrated effort to improve your credit score, so don’t wait until you are one month out from a large financial move before starting to pay attention to your credit.

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