We hear the word “credit” used all the time. Credit scores. Credit report. Credit history. Credit card. Credit bureau. Credit line. Credit rating. Good credit. Bad credit. But what do all those credit terms really mean?
You are more likely to be judged worthy of taking on a loan or other financial obligation if you have good credit. It is a measure of your ability to handle your finances — and your ability to pay. And you’re also judged more likely to be responsible in how you manage their life as a whole.
How does your credit get judged to be “worthy”?
Should numbers (like a good credit score) really have the power to judge you as more responsible in general? Phew! That puts a lot of weight on mere numbers that affect so many aspects of your life. And yet it’s also something you have no say in when the actual measuring is being done.
You’re being judged by people you’ll never see. And I know that doesn’t feel fair. It isn’t. But you still have to deal with the results others come up with. So your best defense is to arm yourself with knowledge in advance.
Also, at least in this country, there are other powerful forces who get to judge you. All-powerful Credit Bureaus — and a company called Fair Isaac — decide just how credit worthy or unworthy you are. More info on that here:
So what’s the meaning of all those credit terms?
On the good side, credit gets you money right now from some lender or financial service. But first the lender needs to make sure you can actually repay the loan. So they also assess your likelihood to load yourself up with lots of additional debt. Even if your credit rating looks ok now.
Some words that are part of the process:
Credit scores – A numerical value developed to make it easy for lenders to see how credit worthy you are. At the moment, a company called Fair Isaac Corporation has 90% of the credit score business. So odds are your lender either uses their number directly or as part of their own formula. And this is NOT the same as a credit report.
Credit report – Credit bureaus (see below) issue a report that details the status of your current credit and credit history from all lenders (i.e., credit cards, loans, mortgages) you’ve worked with. It will also show late payments. But also any public filings such as bankruptcies and liens.
You are entitled to a free credit report every year from each of the three major credit bureaus. You can find how to get that on Annual Credit Report.com, the only federally authorized site to do so. Use it check for accuracy and identity theft (any new accounts opened in your name.)
Credit history – Details of your accounts and payments (late or on time or not at all) plus any other negative info, as mentioned above. Negative info stays on your report for 7 years; 10 years for Chapter 7 bankruptcy.
Credit card – A card issued by lenders such as banks, credit unions, and department stores that lets you pay for things without cash, with the underlying service often provided by major non-banks like Visa, American Express, MasterCard, and Discover. It operates much like a “revolving credit” where, for a set interest rate, the lender offers you the right to borrow up to a set limit; the amount available to you replenishes itself as you pay back money.
After a period of timely payments, the lender often raises the borrowing limit — hopefully encouraging you to use more of its money. While it’s best for your financial management to pay the full amount owed every month, if you can’t pay it all at least pay more than the minimum, otherwise you wind up paying the lender tons more than you borrowed.
SUGGESTION: If you’ve managed your credit well, call the card company to lower the interest rate. If they say no, see if there are other more accommodating cards out there. Hopefully with better rates (and NO FEES) so you can to transfer the debt. Be sure to tell your present lender about that, in case they reconsider. And when it comes to cards, less is definitely more.
Credit bureau – Companies that issue credit reports and now also provide credit monitoring and identity theft protection. The major players are Experian, Equifax, and TransUnion.
Credit debt ratio – For all currently active credit products, total borrowed amount divided by total credit available to you. Potential lenders use this (as with mortgages) to see if you’re stretched too thin to risk lending to you. Even if you have a good credit score, if you’re close to your lending limit, this can affect your ability to get a new loan.
Credit risk – How likely you are, in the eyes of the new lender, to repay the money you are borrowing.
Credit line – This is a type of loan, usually issued for operating expenses or a project of some sort. Although you can use it as needed and don’t need to take it all up front (other loans may be better for that), it’s different from a revolving loan in that as you use it up the available credit is gone. It doesn’t fill up again the way a credit card does.
Credit rating – This is an general assessment of your basic credit worthiness. Do I want to lend to or do business with you, and how much under what terms? The kinds of things that go into determining this are:
- How timely & consistent are you in making payments
- The credit debt ratio of your total debt to your total available credit. (High is bad; very low or zero is good. )
- The number of credit accounts, kind of credit, and how long you’ve had them
- Anything else out there in public databases they might find out about you
Good credit – Depends on the lender and type of loan and the lender’s particular credit score range. FICO scores in the upper 700s and 800s are considered good. A general range by credit rating (according to Credit.com) is:
- Excellent credit: 781 and above
- Good credit: 661-780
- Fair credit: 601-660
- Poor credit: 501-600
- Bad credit: 500 and below
Bad credit – Again depends on the lender and their particular credit score range. See chart above, remembering it’s just a general feel for the way an individual lender might see your score. And any solid indications of recent, sustained improvement may help sweeten their take on you.
Credit terms – I used the phrase earlier to refer to the credit-related phrases in this article. But the phrase “credit terms” has its own technical meaning in the world of credit. They are the contractual requirements / mutual commitments between you and the lender within the credit agreement you sign.
Putting those credit terms into action
Credit can be a wonderful thing. Ideally it lets you have things you need now that you don’t have cash for, but know you can afford. But it can also remove that “can I afford it now?” question, since it’s so easy to just swipe a card or “Buy It Now” online.
If you have no willpower, then credit can bring you to the edge of bankruptcy — or at least to a very bad credit profile — faster than you can imagine. So it’s good to be honest with yourself about this.
But if you use credit wisely and only when truly needed, doing your best to minimize those interest payments, it can be a wonderful tool for your overall financial management picture. Just try to use it sparingly for things you don’t really need, ok?
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