Your personal credit is your reputation as a borrower of money, and it’s an indicator of how likely you are to pay that money back. People with the best credit are seen by lenders as very reliable borrowers, likely to pay the money back on time and in full. Those with the worst credit are seen as very risky borrowers who may not pay the money back.
To understand credit, think of a trusted friend you have known for a long time. How comfortable would you feel loaning her $300? Now think of someone you barely trust and just met, and ask yourself the same question.
In the first situation, you see the person as a reliable borrower, likely to pay your money back. But in the second situation you don’t feel quite so comfortable and maybe you wouldn’t want to loan the money at all, or maybe you would make the person promise that they would pay you back $350. Lenders of money go through a similar process when they consider giving you a loan, but they use your credit reports and credit scores.
Your credit is important when it comes to getting the best terms on:
- Credit cards
- Auto loans
- Insurance approvals
“Know the power of credit. Banks look at your credit history as an indication of your future financial behavior. By using credit wisely, you can build a good credit history. A good credit history makes it easier to get loans with low interest rates, rent an apartment, purchase a car or home, and may even help you get a job.”
– Lorene, The Mindset Matters
You build credit by establishing a history as a reliable borrower, which means taking out loans and then paying them back. This includes student loans; if you’ve begun paying back student loans you’ve already established a credit history.
In general, the longer your history of good behavior, the better your credit will be. If you make late payments, fail to pay your bills, or otherwise prove yourself to be a risky proposition.
This information is collected and summarized in your credit reports. There are 3 main companies that release their own versions of these reports, known both as “credit reporting agencies” and “credit bureaus”:
You can get a free copy of your 3 credit reports once per year from AnnualCreditReport.com, a federal website. You can also pay for copies of your credit reports if you wish.
A credit score is a single number that summarizes a credit report. FICO is the most important credit scoring model, used by most lenders, though VantageScore is important as well. Credit scores and credit reports are separate entities, though the scores are based on the reports.
A FICO credit score is composed of 5 different parts:
What’s In Your Credit Score?
This chart shows the criteria used to create FICO scores and their relative importance in your credit score.
The FICO scoring model analyzes your credit report based on these criteria and provides a number ranging from 300 to 850. A higher score means that you will qualify for more types of financial tools, like great credit cards, as well as more favorable terms.