What is credit?
Credit is best defined as your “financial trustworthiness”. Your credit history is the most important factor considered by lenders when you apply to borrow money. Lenders offer lower interest rates, better loan terms, and other benefits to those with good financial standing. Building good credit is the first step in establishing financial independence. Some ways you can build good credit are:
- Keep the percentage of available balance used low. This helps to keep a positive debt-to-income ratio
- Pay at least the minimum payment amount required each month. Pay more if you can.
- Paying your bills on time
How does credit work?
When you are issued credit by a lender, you are given the ability to purchase goods and services you could not otherwise afford without credit, provided that you pay the money back. The lender makes money by charging fees, interest, etc. The cost of borrowing money is dependent upon how much is borrowed (principal), how long it takes the money to be repaid (term), and the interest rate you are being charged. Lenders issue credit if they believe you will pay it back.
Earning this level of trust is also referred to as “establishing credit”. Each time you borrow and pay back borrowed money (on time), you strengthen your credibility.
Credit allows you to purchase big-ticket items, such as a house, car, etc., that you wouldn’t necessarily be able to afford all at once. You purchase the item with the borrowed money and pay the purchase off over a period of time with interest. Interest is the cost of using money that is not your own.
However, using credit comes with serious risks that could have negative effects on your current and future financial standing.
How do I get credit?
In order to obtain credit from a lender, you must apply either in person, on the phone, or online. The lender will consider a variety of different factors when deciding whether or not to issue you credit. Decisions can take anywhere from 30 seconds to several weeks.
Sometimes it takes credit to build credit. Consider starting with a secured credit card. See Types of Credit for more information.