Finance 101 Fuzzy on How Credit Works? Here’s Help

by Megan Nye | May 16, 2018

Remember that college course you had to take about managing your credit? No? Don’t worry, you didn’t miss it. 

And you probably never attended a seminar on one of the most important and frequently misunderstood areas of finance, either — your credit.

So it’s no surprise that some people struggle with understanding and managing their developing credit histories. In fact, a recent LendEDU survey found that only 25% of millennials could correctly define what a credit score is, and only 17% knew one of the best ways to improve their score. Today, it’s time to set the record straight. Here’s the scoop on what really makes a difference when it comes to your credit. Below you’ll find some of the secrets to taking control of your financial destiny with a few easy strategies.

What’s the skinny on credit?

Let’s start with the basics.

At its core, credit is borrowed money. A lender, card issuer, bank or grantor gives you a set amount of money to use with the expectation you’ll repay it according to agreed-upon terms. Those terms can include repayment dates, required minimum payments, interest rates, fees and more.

Of course, credit comes in many forms. Your own personal use of credit may include mortgages, car loans, student loans, credit cards, personal loans, home equity loans, or lines of credit and consolidation loans.

Your creditworthiness, meanwhile, is determined on the basis of your reported credit history. What type of information is included in your credit history? In general, you’ll see the following sections in a credit report:

  • The name(s) under which you’ve obtained credit
  • Your current and prior addresses
  • Information on your credit cards and revolving lines of credit: the age of the account, the balance, your credit limit and the timeliness of your payments
  • Details about the loans that are in your name
  • Specifics of accounts that you may have closed within the last several years
  • Notes on any outstanding debts that have gone to collections
  • Notes on any bankruptcies, foreclosures and repossessions that have happened within the last several years
  • A listing of any businesses and individuals who have requested your credit report within the last two years

Keep in mind that your credit report won’t include information on your banking or investment accounts, debit or prepaid cards, bankruptcies that are more than a decade old, debts sent to collections that are more than seven years old, and personal information like gender, race and religion.

Plus, your report won’t include your credit score.

Your credit score is a number that represents the information contained in your credit history. According to Experian, one of the three major credit bureaus, “good” credit is characterized by a credit score of 670 to 739. A credit score of 740 to 799 represents “very good” credit, the bureau says, and a score of 800 to 850 signifies “exceptional” credit. Approximately 60% of Americans have credit scores that qualify them for one of these three categories.

Credit worthiness is determined on the basis of your reported credit history.
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Who cares how fit my credit is, anyway?

A whole lot of people, as it turns out. In fact, a number of businesses may request your permission to view your credit report.

Of course, there are potential creditors. Before extending you a loan or line of credit, a lender will want to assess your creditworthiness. That element, combined with the other details of your credit application, determines whether your application will be approved and for what lending terms you’ll qualify.

Existing creditors may also wish to review your credit history on a regular basis or whenever you’re looking to renegotiate loan terms or increase your credit card spending limits.

Beyond lenders, other people and businesses you interact with have an interest in your financial health:

  • Utility companies actually offer you a form of credit, since they provide a service and trust you’ll pay every month. So they may want to see how well you’ve kept up with your utility payments in the past.
  • An insurance company can, in most U.S. states, use a version of your credit score in calculating the premium you’ll pay for auto, home or renter’s insurance.
  • A landlord may require that you meet specific credit criteria in order to rent a home or apartment.
  • A potential employer may run a check to project your ability to handle customer money or even assess whether financial troubles might tempt you to defraud the company.

If you’re looking to get financing on a big purchase, such as a house, car, motorcycle, home renovation or furniture, you should anticipate a credit check.

Those with a credit score of 800 or more are typically offered easy loan approval, some of the best interest rates, higher card limits, access to exclusive perks or rewards, and the most options for structuring a loan.

Plus, maintaining good credit tends to be good for you. Having poor credit has been known to bring on financial stress. So staying healthy and informed in your money matters can be one way to contribute to your overall physical and emotional health.

woman in office setting smiling with hands folded

I’m sold. How can I get started building up my credit?

If you’re on the verge of wading into the world of credit, you may be wondering how you can apply for a credit card when you don’t actually have any credit history for a lender to review. For new credit users, there are a few options for getting started:

  • Apply for a traditional (or unsecured) credit card. Based on your credit history, a bank or credit union with which you already do business may be happy to offer you a traditional credit card.
  • Consider a secured credit card. With no credit history, it’s possible that you’ll be turned down for a traditional, unsecured credit card. A secured credit card is another option. With a secured credit card, the card issuer requires the applicant to make a cash deposit as collateral before opening up an account. Make sure to consider credit card issuers who report to credit bureaus so that, with timely payments, you have the opportunity to build a stronger credit history.
  • Become an authorized card user. If your parent or spouse is willing, he or she could choose to add you as an authorized user of his or her credit card. Some credit scoring models don’t give authorized users’ activity as much weight as that of primary cardholders. Nonetheless, if a card issuer reports on authorized users to the credit bureaus, you may be able to start building a financial history for yourself.
hands holding credit card and using laptop

How can I maintain or strengthen my credit once it’s established?

Already a credit user? It pays to assess your existing credit cards regularly in order to determine whether they’re still right for you. Does your current credit score qualify you for better terms or even more exclusive cards? Have your spending habits or life circumstances changed since you first got your cards? Are there new cards on the market that are a better fit for you?

No matter where you are in your credit journey — just starting out or fine-tuning your approach to finance — always read the fine print before you get a new card or open a line of credit. Be sure to understand your credit limit, the APR, annual fee amounts, maintenance fees, surcharges, grace periods and more.

Once you have some credit available to you, it’s up to you to build and maintain a clean history of borrowing and repayment. In general, the value of your credit score will depend upon these factors:

  • The timeliness of your bill payments
  • The amount of credit that you use
  • The amount of credit that’s available to you
  • The length of time that you’ve been using credit
  • The types of credit and loans that you utilize
  • The frequency with which you request additional credit

So, if you’re looking to build your credit, follow some basic rules:

  • Do pay your bills on time every time. Late payments on your mortgage, your student loans, your credit cards, your utilities and medical bills and more can all appear as black marks on your credit report.
  • Do limit the amount you charge on your cards relative to their credit limits. This percentage is known as your credit utilization ratio. Very high utilization may negatively impact credit health.  
  • Do keep your older credit cards active. They can add to the length of your credit history and contribute valuable points to your credit score.
  • Don’t use credit to fill a gapYou’ll dig yourself into debt by splurging on lifestyle perks you can’t afford.
  • Don’t believe the myth that carrying a credit card balance builds your credit. If you can pay off your cards every month, do it. You’ll avoid costly interest payments.

Looking to ensure you’re on track as you work toward an exceptional credit score? You’ll want to monitor your credit history closely.

Once you have some credit available to you, it’s up to you to build and maintain a clean history of borrowing and repayment.
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How can I monitor my credit?

When you’re committed to building a healthy financial history for yourself, checking in regularly on your progress is a smart way to see the fruits of your efforts and identity factors that are slowing you down.

Start by reviewing your credit report. You’re legally entitled to receive a free credit report from each of the three major credit bureaus every year. Pull them all at once, or grab the three reports in stages over the course of the year.

When you receive your report, read it thoroughly. Confirm that all the information provided is correct and current. Is your address right? Is the data reported for each of your accounts accurate? Is there activity or an account that’s unfamiliar to you?

Your credit history is an invaluable tool in helping you catch small problems before they grow into bigger ones. For instance, you may find that a bill you thought you paid is listed as past due or that a loan for which you co-signed isn’t being paid off on schedule.

If you find incomplete or inaccurate information, contact the credit agency from which you received the report immediately. Faulty information may improperly blemish your financial history, lower your credit score, and prevent you from enjoying the benefits of the creditworthiness you’ve rightfully built.

At the same time, credit report errors may indicate identity theft — an increasingly common crime. If you suspect that you’re a victim, place a fraud alert on your credit report to prevent someone who’s not you from opening new lines of credit. If your credit card has been misused, contact your card issuer to cancel the card and initiate a dispute. Head down to your local precinct to file a police report and consider signing up for a credit monitoring service.

Remember that your credit history report does not include your numeric credit score. And, while many types of credit scores exist, all of them are computed from the information in your report. Want to see yours? You can order one or many scores online.

When you do order a credit score, you’ll of course want to review the score itself. But you should also examine the “risk factors” or “potentially negative items” that you’ll receive alongside your score.

These elements detail what’s keeping your score from being even higher. For instance, you may find notes that indicate you have high balances or frequent late payments. And that section of information may offer insight into how you can improve your score even further.

Your credit history is an invaluable tool in helping you catch small problems before they grow into bigger ones.
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So are you ready to conquer your credit? Armed with the right information, you can implement an easy-to-follow strategy today. Start building (or rebuilding) your credit, seize control of your finances, and position yourself to enjoy the perks of a fit and healthy credit score.

Megan Nye

is a personal finance freelance writer. Her writing has been published by Business Insider, Credit Karma, Lending Tree, U.S. News & World Report, Personal Capital and Northwestern Mutual.