How Credit Works
What happens when you cannot afford something you really need at the moment? The simple answer to this is credit.
Credit affects just about every part of your life. Credit has impact on employment, loans, mortgages, and so on. If you have any financial goals, you’re going to need some credit.
As nice as it is to own a credit card, people can end up getting into a lot of debt. And that’s why it’s important to understand how credit works and how it can impact your life every single day.
This is where Credit Bull can help by simplifying things. In this article, we will tell you what you need to know about credit and how you can have good credit.
What Is Credit?
Most people are familiar with the concept of credit, lets break down the two different forms of credit for you. First, as an agreement between a lender and a borrower for goods and services that will be paid for at a later date. And upon agreed terms and conditions.
Second, as your credit history, creditworthiness, or reputation. And this affects how much you are allowed to borrow from a lending institution. Or better still, whether or not you’ll get a favorable interest rate.
This is why you need to build your credit. And in doing so, you must keep an eye on your credit report or credit score. We’ll talk about what this means later on in this article.
Is There Different Types Of Credit?
One way to boost your credit score is to have different types of credit. Having a mix of credit account types and paying them off can help show lenders that you’re responsible. Creditors will typically see you as less of a credit risk when you have a mix of credit types.
This is because it shows that you can successfully manage different forms of credit and the payment systems associated with them.
So here are types of credit you can explore:
#1. Installment credit:
This credit involves you borrowing an amount of money to be repaid in monthly installments over a fixed period. And the interest rate is calculated and added to the monthly installments. Most loans like mortgage, car loans, student loans, personal loans fall under this type of credit.
This type of credit falls under secure loans because security is involved in case of default. This means that the borrower must provide security in the form of collateral before he can borrow. And it also guarantees repayment. With this, the lender also has something to fall on where the borrower defaults to pay back.
#2. Non-installment or service credit:
With this type of credit, you can pay for a service or membership at a later date. Payment is usually due at the end of the month following the service. And default in payment attracts penalty charges, fees, or disconnection of service.
There is also the risk of being reported to the credit bureau, and this will affect your credit score.
Examples of this type of credit service are cell phone services, garbage, electricity, water, gas, etc.
#3. Revolving credit:
This type of credit allows you to borrow up to a certain amount or limit when you need it. So you don’t have to borrow all at once. And once you have paid back the debt, you’re allowed to borrow up to that limit over and over again. Hence the name ‘revolving credit.’
There is no set repayment time with this type of credit. And if you do not have any pending debts, you have no payments to make. However, there’s a tendency to run into major debts if you keep carrying over the balance even while paying the minimum required sum.
Credit cards, lines of credit are types of revolving credit. And it is also known as unsecured credit because no collateral is involved.
#4. Charge card:
While this is similar to revolving credit, the difference is that here you cannot carry over a balance. Instead, money borrowed must be paid in full each month, or you will be penalized.
This helps you not accumulate pending balances which translate into bad debts.
Why Do You Need Credit?
Good credit history is a major step to financial security, so you need credit to have that. With good credit, you can get a car loan, rent an apartment, get a mortgage, and so on, at favorable rates.
A 5% interest rate instead of 8% may not seem like much until the difference is in hundreds of thousands of dollars. That’s a big save which enables you to have more money for other financial obligations. You can even get a 0% interest rate at the beginning of a loan term if your credit is exceptional.
Also, believe it or not, some employers look at your credit history to know if you can be employed or not.
What Is A Credit Report?
A credit report is a complete detailed report of your credit history. It includes all your credit accounts, the length of each, and how well you’ve managed them. It also includes possible red flags like bankruptcies, public records, foreclosures, and so on.
Basic information like your name, social security number, date of birth, current and last addresses are also contained in a credit report. And it also includes any inquiry made into your account.
What Is A Credit Score?
A credit score is a three-digit number that shows whether or not you are creditworthy. And it’s found on your credit report. The number may range from 300 to 900, depending on the scoring model.
So the higher your credit score, the better your credit report. The two most used models are FICO® Score and VantageScore.
How Do You Get Good Credit History?
It takes years, patience, effort, and integrity to build a good credit history. It begins with establishing credit for the first time, which is easier when you’re young and dependent. Then, you can take out a federal student loan or ask a parent to make you an authorized user on any of their credit cards (credit piggy banking).
From here, knowing what goes into your credit score and watching out for them will help you get a good credit history. However, some tips on getting good credit history include:
#1. Use credit:
You can’t have a good credit history if you don’t use credit. In fact, building credit involves a healthy mix of loans and revolving credit. One of the requirements of FICO is that you should have credit-related activity within six months to qualify for a score.
#2. Track your credit score and report:
As you use credit, keep a tab on how you use them. Inquiries like this into your credit score and report are called soft inquiries and don’t affect your credit score, unlike hard inquiries. The latter is done by lending institutions.
#3. Make payments on time:
Doing this helps you establish a good credit history. If you’re fallen behind, catch up as fast as possible.
#4. Keep card balances low:
This shows that you’ve been able to pay up your bills before the end of your billing cycle. But a high balance shows that you’re in way over your head.
#5. Take wise loans:
Taking up too many loans within a short time can be hard to keep track of and pay off. So before applying for a loan, make sure you’ll be able to afford the payments.
Factors That Affect Your Credit Score
Based on the FICO® Score model, here are some factors that affect your credit score:
This makes up 30% of your credit score. How much balance you carry over on your credit limit affects your credit score.
The best thing to do is limit your credit card utilization and pay off your balance before your billing cycle date. Don’t wait until the end of the month or frequently use up all your available credit before paying up your balances.
This is because carryover balances will reflect on your credit card statement even though you paid off all your balances at the month’s end. So try to pay off all or most of it before your credit card billing date expires.
Your credit record includes your payment history, which affects your credit score. As a matter of fact, it accounts for up to 35% of your credit score. This is why making payments on time consistently is important. The longer you take to make payments, the lower your credit score.
This makes up 10% of your credit score. Every time you have to take new credit, you open yourself up to a hard inquiry into your credit history. And each time this happens, your credit score takes a beating.
So avoid taking on too many new credits, especially within a short time. This is a major red flag on your credibility.
Length of credit history:
This accounts for 15% of your credit score. It’s how long you’ve been using credit and the average age of your credit account. So try to maintain a good length on a credit card.
If you’re on a public record, it means that you’ve probably been sued over a debt. And this can reduce your credit score greatly. This also applies to a bankruptcy filing. To recover from this and build good credit usually takes years. It’s like you’re building your credit all over again.
How Do You Track Your Credit Score?
There are different ways to do it. One way is to check websites that provide free access to your scores, like Experian.
Another way is through your lender. Many banks and financial institutions provide free access to their customers to check their credit scores.
What Do You Do If You Have A Bad Credit Score?
Start by paying off your bills and existing loans, and don’t apply for new credit. This helps you start on a clean slate while building better credit. It may take a while, two or more years, but the result is well worth it.
In the process, get a secured credit line. This requires refundable collateral and so will help you to pay off loans faster instead of accepting balances.
Note that sometimes a bad credit score can be a result of identity theft or errors on your credit. In this case, report to the credit reference agencies like Experian, Equifax, and TransUnion.
You may have already gone on a path to bad credit. But not to worry, we’re here to help. CreditBull.com can help with all of your credit needs.
CreditBull Inc has over 20 years of experience in credit and financial matters. And we specialize in helping you come out of a bad credit situation. We know how important good credit is, and we can help make your life easier by helping you get better credit.