What Is Credit?: My Own Knowledge

  

 In times credit has become more of a necessity, for consumers than just a luxury as it used to be. With the advancements in internet and communication obtaining credit has become more accessible than before. If you're interested in understanding credit this guide aims to provide you with an overview of what credit entails what a credit score signifies and the various types of credit available.

What does credit mean?

In terms credit refers to the system of borrowing from an entity with an agreement to repay the borrowed amount along with money known as interest. Lenders earn money by charging interest typically calculated as a percentage of the borrowed sum.

For instance if you lend $100 to a friend with a 10% interest rate your friend would need to repay $110 ($100 + $10). This way your friend benefits by receiving the required funds while you also benefit by earning $10. This serves as a concept of credit; however in the realm it becomes more intricate due, to various loan types and differing interest structures.

Read: What is Good Credit And How To Get The Best Interest Rates

What is a credit score?

A credit score, also referred to as a credit rating is an assessment that reflects an individuals ability to repay the loans they receive. It can be likened to a report card or evaluation of your decision making.

The calculation of a credit score is not performed by banks or financial institutions themselves. Instead it is generated by credit agencies or bureaus using a model. The used scoring model is called FICO, which stands for Fair Isaac Company. While the exact formula, for calculating your credit score remains confidential we will discuss the components that have an impact on this number later on.

The determination of a person's credit score involves employing an algorithm executed by the credit bureaus taking into account factors from their financial history. Credit scores generally range from 300 as the minimum to 850 as the maximum. A higher score indicates risk when applying for loans, from banks or other lenders.

 

How exactly is one credit score calculated?

If you're aiming to build a credit profile that can help you secure a home obtain a car loan or enjoy interest rates it's crucial to understand the key factors that impact your credit score. Here are some important aspects to consider;

1. Credit Score; Payment History

When calculating your credit score your payment history carries weight accounting for 35% of the calculation. This implies that financial institutions place emphasis on payments. As a guideline; making payments, on time boosts your score while late payments have an impact.

A significant drop, in your credit score can occur if you experience a delay or late payment on your existing credit cards. To avoid this ensure that you make payments towards all your debts and loans each month. Late payments can also raise concerns for lenders potentially leading them to decrease your credit limit due to the perception of an increased risk of default.

2. Credit Score; Credit utilization

Your credit utilization has a 30% impact on your score. It is calculated as the ratio between the amount of credit you owe and the maximum approved credit to you. For instance if you have a credit card, with a $1,000 limit and currently owe $500 your credit utilization would be 50%. Generally speaking maintaining levels of credit utilization contributes to achieving a score.

3. Credit Score; Length of account history

It is advisable to establish your credit as soon as possible. Opening accounts and consistently making payments from an early stage will work in your favor. The length of your account history accounts for 15% of your credit score.

The length of your credit accounts holds significance when dealing with mortgage lenders or applying for a home loan.

If you maintain a credit score, over an extended period and demonstrate a history of timely payments your likelihood of securing approval for long term loans such, as a car or home loan significantly improves.

Lets consider this scenario; If you had to lend $1,000 would you choose someone, with a 10 year history of payments and no outstanding debts or someone who only has one month of records? It's also important to keep your accounts open even if you're not actively using them because they contribute to the length of your credit history regardless of whether they have a zero balance.

4. Credit score; Different types of credit

The types and variety of credit you utilize and apply for can also impact your credit score. There are four categories; loans, revolving credit, consumer financing and mortgage loans. Experts have indicated that some types of credit carry more weight in determining your score than others; however the precise numerical values are unknown.

Mortgage loans; These loans are specifically used for purchasing homes. Hold influence over your overall credit score.

Installment Loans; Fixed payment loans like car loans fall into this category and come in place when it comes to their impact, on your credit score.

Revolving Credit; This category covers credit cards and any lines of credit that allow you to borrow money as specific store or location based credit accounts, like Macys, JcPenney, Sears and others. These types of credit make up a factor in determining your credit score.

Consumer Financing; This category includes loans such as title loans, secured loans, cash advances and even some mortgage or auto loans with interest rates. These loans are typically offered to individuals, with credit history ( referred to as subprime credit).

Read: How to Climb the credit card tier list

5. Your credit score; Understanding credit inquiries

When it comes to your credit score credit inquiries play a role accounting for 10% of its impact. Each time a financial institution requests a credit inquiry, like when you apply for a line of credit a credit card, a mortgage or a car loan it has an effect, on your score.

There are two types of inquiries that can be made on your credit report. However the ones that have an impact on your score are referred to as "credit checks and are commonly seen when applying for new credit. Each hard inquiry indicates a search for credit options and may lead to a slight decrease in your score by 5 to 10 points.

It's important to note that while building a credit score takes time and effort damaging it can happen more quickly than you might expect.

If you're considering loan options and want to compare them before making a decision the major credit bureaus such, as Equifax, Experian and TransUnion take into account all the inquiries made within a specific period (typically 30 days) and consolidate them into one inquiry so as not to heavily impact your overall credit rating.

Another type of credit check that has an impact, on your credit report is called a credit check. It's the option if you want to check your credit for free. A soft inquiry occurs when your credit is accessed for reasons, other than obtaining credit like reviewing your credit report to look for errors or when an employer needs to review your credit. These types of inquiries don't show up on your credit report.

Are you struggling with a credit score? Are you looking for ways to improve your credit? Don't miss out on our guide titled "Steps to Enhance My Credit " where we provide a step, by step approach to boosting your credit score.

What Is Credit?: Any Questions and comments

Now that you have an understanding of what credit's are aware of the factors that impact your credit report it's time to begin building your credit. If you have any queries or uncertainties regarding how these factors affect your credit score or if you need information, on establishing credit please feel free to leave a comment. We are here to help address any concerns or questions you may have.

Additionally if you have any suggestions based on experiences that have helped improve your own credit score kindly share them by leaving a comment below. We will carefully. Consider adding them to our article for the benefit of our readers.