The ability to effectively manage your credit is a key component of financial literacy and the purpose of today’s article is to briefly shed light on a few credit essentials.

What is credit, and why is it important?

Before we get into what factors make up a credit score, it’s helpful to grasp why it’s necessary in the first place. The short answer is that credit enables consumers to borrow money for purchases they may not be able to buy in cash. Lenders offer a sum of money with the understanding that the borrower will pay back the funds over time, often with added interest.

Credit is used by a vast majority of the public, with the Census Bureau reporting that more than two-thirds of Americans have at least one credit card.

What is a credit score?

A credit score is a track record of a borrower’s ability to pay back borrowed money. Credit scores can affect the interest rates on loans and even impact car insurance premiums and home rentals.

What types of credit are there?

There are generally two types of credit: revolving and installment. Revolving credit includes things like credit cards and lines of credit. With revolving credit, the borrower has a set limit they can spend up to, and payments are calculated based on the amount borrowed each billing cycle. The available credit renews each time a payment is made towards the principal amount, enabling the user to borrow and pay back repeatedly.  

Conversely, installment loans are borrowed in full. Borrowers typically have a set amount of time to pay back the loan plus interest, often with a fixed payment each billing cycle. A car loan or a mortgage are common types of installment loans.

Who manages credit scores? 

Three primary credit bureaus handle credit reporting in the United States: Experian, Equifax, and TransUnion. Lenders will report a borrower’s payback history to one or all bureaus. Lenders will also reference these same bureaus when deciding on whether to give money to a borrower.

Did You Know? You are allowed one free credit report from each bureau per year. Visit AnnualCreditReport.com or call 1-877-322-8228 to get yours. PRO TIP: You do not have to view reports from all three bureaus at once, meaning you can space them out for almost a full year of credit history. 

How do I build my credit?

Credit cards can be a great starting point for anyone building credit. As a credit novice, opt for cards with lower limits and increase your limit as you build up healthy credit habits over time. If you are unable to qualify for a card on your own, consider becoming an authorized user on someone else’s card. It’s important to note that some creditors do not report authorized user activity to the credit bureaus, so make sure yours does to take advantage of the credit building opportunity.

Alternatively, you may opt for a secured loan or credit card. Money put down by the borrower guarantees these loans and lines of credit, and creditors are more likely to offer them because there is collateral in case the borrower doesn’t pay. This might be a great option if you have funds to put down as security.

Managing credit correctly

Once you’ve established some credit, it’s important to manage it wisely. The following tips will help you as you navigate your credit journey.

Pay on time

Make your credit payments on time to signal to lenders that you are a responsible borrower. It will help you raise your credit score over time and avoid unnecessary late fees.

Avoid too many inquiries

Creditors will typically pull your credit report when you apply for credit, and a few inquiries are a normal part of the process. Prepare yourself before applying by checking your report and asking questions.

Diversify your credit usage

It’s a good idea to establish both revolving and installment loans to show the ability to handle different types of credit. As always, make sure you can manage the debt you’re taking on to ensure steady, on-time payments.

Stay informed

You don’t want to be surprised by anything negative in your credit history. That’s why it’s important to keep track of your credit usage. Pull your free report and utilize any tools at your disposal that may automate the process. You may also want to consider setting up automatic payments for any loans and lines of credit so that you can avoid any missed payments.

There you have it, some credit basics to get you started on your credit journey. Check out our Smart Cents site to read more articles all about financial literacy, saving, budget, and more.

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