What is Credit and Why is It Important?
Credit is part of your financial power. It helps you to get the things you need now, like a loan for a car or a credit card, based on your promise to pay later. Working to improve your credit helps ensure you'll qualify for loans when you need them.
Keep reading to learn about credit reports and scores, how credit affects you, and how student loans factor into your credit report.
What is Credit?
Types of Credit
There are many types of credit. The two most common types are installment loans and revolving credit.
Installment Loans are a set amount of money loaned to you to use for a specific purpose.
Common Examples of Installment Loans
- Student loans
- Auto loans
Revolving Credit is a line of credit you can keep using after paying it off. You can make purchases with it as long as the balance stays under the credit limit, which can change over time. Credit cards are the most common type of revolving credit.
Not all credit cards are the same. Make sure you explore all pros and cons of credit cards when choosing the right one for you.
Interest is a cost of borrowing money. Lenders generally charge a certain percentage of the average daily balance of your account, which is called an interest rate. This interest rate is applied to your outstanding balance on a monthly basis. Credit cards may have different interest rates for different types of activities, like purchases or cash advances, so make sure you read the fine print.
Many credit cards charge fees, but not all cards charge the same fees. Take care to fully understand what fees you are responsible for.
Most common fees
Annual fees are similar to a membership fee—you are charged once per year just for having a card. Return to most common fees navigation
Transaction fees are collected when a card is used for a cash advance. Return to most common fees navigation
Balance transfer fees are fees you pay to transfer balances from one credit card to another. Return to most common fees navigation
Late payment fees are charged if a payment is received after the due date. Return to most common fees navigation
Over-credit-limit fees are assessed if your spending exceeds the credit limit set for your account. Return to most common fees navigation
Return item fees are charged if your payment is returned for insufficient funds. Return to most common fees navigation
Your credit limit is the maximum balance you can have on your credit card. It is determined by your lender, based on your credit history and income.
Credit Origins: Reports and FICO Scores
Your credit report is what the nationwide consumer reporting agencies use to calculate your credit score, which is used by lenders to determine your credit worthiness. The three major nationwide consumer reporting agencies are Equifax, TransUnion, and Experian.
What is a FICO Score?
Credit reports are used to generate a credit score. One of the most commonly used credit scoring formulas is Fair Isaac's FICO score, which ranges from 300 (low) to 850 (high). The higher your score, the more likely you are to be approved for new credit, or offered a lower interest rate. Many factors from your credit history are used to calculate your FICO score. The nationwide consumer credit agencies don't disclose how scores are calculated, so no one knows exactly how they are determined. The agencies may have different data on your credit history, so your score can vary between the agencies.
Your credit report shows your payment history (on time, late, or missed) for the past seven years.
Your FICO score looks at the amounts you owe on all types of accounts. For installment loans, such as student loans or auto loans, paying down your loan can help to increase your score.
For revolving credit accounts, such as credit cards, your FICO score looks at the total amount you owe as well as your utilization ratio. Your utilization ratio compares the amount you owe on your card to the credit limit on the account. It is a good idea to aim to use 30% or less of your available credit.
A longer healthy credit history can mean a higher score. For this reason, it can be beneficial to keep credit card accounts open even if you don't use it regularly and don't have a balance.
Opening a lot of new accounts in a short period of time can lower your credit score, at least temporarily.
Your FICO score considers which types of credit accounts you have experience using. It's usually best to have both revolving (like credit cards) and installment (like student or auto loans) lines of credit, as long as you are able to manage them.
Hard Inquiries vs. Soft Inquiries
Every time a potential creditor accesses your credit report and score, it's recorded on your report as a hard inquiry. Too many of these can show potential creditors that you are attempting to open more than one line of credit and they may choose not to loan you money.
You might also hear about soft inquiries. They occur when your credit report is reviewed when you're not looking to open new credit lines. Unlike hard inquiries, soft inquiries aren't considered by lenders when evaluating whether or not to loan you money.
Examples of Soft Inquiries
- Landlords run credit checks when you apply to rent property
- You accessing your own credit report for monitoring
Your Superpower: Good Credit
Many aspects of life are affected by credit ratings. They may:
- Determine whether a lender approves a new loan.
- Influence your interest rates and fees on the loan.
- Be reviewed by employers before they offer you a new job.
- Be used by landlords when deciding whether to rent to you.
- Determine your student loan eligibility, including most private loans.
- Be reviewed by insurance companies when you apply for many types of insurance, including car or homeowners insurance.
Good Credit vs. Bad Credit
Having good credit means that you are making regular payments on time, on each of your accounts, until your balance is paid in full. Alternately, bad credit means you have had a hard time holding up your end of the bargain; you may not have paid the full minimum payments or not made payments on time.
Negative information generally stays on your credit report for at least seven years.
- Late payments
*Bankruptcies stay on your credit report for 10 years.
The good news is that bad credit can always be improved. Practicing good credit habits can raise a low score, as well as help maintain a good score.
Super Credit Tips
- Always pay bills on time.
- Keep low balances on credit cards.
- Monitor your credit report to ensure there aren't any mistakes. Visit annualcreditreport.com for a free report from each of the three major nationwide consumer reporting agencies once every 12 months.
- Avoid too many credit inquiries in a short period.
- Protect your finances! Keep financial records in order and always watch for fraud and scams.
Student Loans and Credit
Your student loan payments, on-time or missed, are reported to all three nationwide consumer reporting agencies. Your servicer begins reporting on your loans immediately after disbursement.
While you're in school, your payment amount displays as zero dollars and your account status displays either pays as agreed or current, meaning your account is in good standing.
While you're in your grace period, your account status continues to display either pays as agreed or current.
Once you begin repaying your student loans, your scheduled payment amount determined by your repayment plan displays on your credit report. If payments are made on time each month, your student loan account continues to display pays as agreed or current.
Your student loan payments, on time or missed, are reported every 30 days. Once a late or missed payment is reported, Great Lakes can't remove it from your credit history unless there are extenuating circumstances or it's determined that you were in school, in a deferment, or in your grace period.
If you miss too many payments, your loan can go into default. When this happens, the account status changes to claim has been filed with the government, indicating the account was paid by a government claim, resulting in a balance of zero dollars. Defaulting on a loan lowers your FICO score, and makes it harder to be approved for new lines of credit. If this happens, contact your servicer to learn about options for rehabilitating your loan to get your account back into good standing, which will get you back on track to improve your score.
Additional Resources for Building Strong Credit
Even superheroes need to work out to stay strong. These financial workouts help you build strong, healthy credit.
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