What is Credit?

Credit is the ability to borrow money or access goods/services with the understanding that you’ll pay later. Your credit is your reputation as a borrower, it determines how likely you are to repay your debt.

Lenders, banks, merchants, and service providers (aka creditors) grant credit based on their confidence you can be trusted to pay back what you borrowed.

Why is Credit Important?

Good credit is necessary and important if you plan to borrow money for major purchases, such as a car or a home. You’ll need to prove to lenders that you can handle your financial obligations.

The Five C’s of Credit

It’s important to remember that methods and factors may vary by lender, but typically, a lender will determine whether you’re a good credit risk (aka how likely you are to pay the loan back, as agreed). A few key factors that lenders may use include:

1. Credit: (sometimes called character) how you have paid your bills or debts according to your credit reports
2. Capacity: your present and future ability to meet payments
3. Capital: the value of your assets and net worth
4. Collateral: (for secured loans only) the assets you offer to secure the loan
5. Conditions: (not used by all lenders) how you plan to use the money

TIP: According to Investopedia, some consider the criteria that lenders use as the four Cs. Conditions are sometimes excluded to emphasize the criteria most in control by the borrower.

The Impact of Credit on Your Lifestyle

While you may not currently be in the market for a house, your credit score and history is still important. Landlords use your credit to decide whether to rent to you. After all, property rental is a loan, and owners want to be sure they will be paid back.

Before you can buy a house, mortgage lenders want to know that you won’t default (not pay) on your mortgage. If you do not have good credit, the lender will consider it risky to offer you a mortgage loan.

If you’re approved for a mortgage, your credit affects your interest rate and interest rates directly impact your monthly mortgage payment. Companies may use your credit scores as a factor in determining your home insurance rates.

TIP: Bad Credit = Higher Interest Rates = Higher Payments

While unexpected, utility companies may check your credit before opening an account or borrowing equipment. Electric companies technically state that you’re borrowing one month of electric service. Before turning on your electricity, the company will check to see if you have good credit. Most utility services conduct credit checks, including cable, telephone, water, even cell phone service providers.

Prospective employers may use information found in credit reports to make a hiring decision. Your credit report can even be used to verify your identity, and for other purposes defined by federal law. Many employers conduct credit checks as part of the hiring process.

TIP: Employers can check credit reports, not credit scores. Employers and landlords typically cannot access your credit report without your written permission.

--------------------------------------------

For more tips on how to build your credit, click here

Learn more about Borrowing Basics here.