Wouldn't it be great to always have enough cash to buy whatever you needed or wanted? Few people have the kind of liquidity it takes to make big ticket purchases with cash, which is why we have credit. When used wisely, credit can help add value to your life by allowing you to afford necessities and extras you might not otherwise be able to buy.
Credit can fund your purchase of a home to live in and a car to drive. It can also finance life-enhancing extras like a backyard swimming pool where you'll relax and exercise, or a boat or RV where you'll escape to spend quality time with your family and make memories to last a lifetime.
Why credit can be good
People use credit to buy and improve homes, purchase and repair automobiles, take trips, and pay for higher-priced items they want or need. Credit can fill in affordability gaps when you don't immediately have cash to pay for things you need or want. However, that's far from the only benefit of using credit wisely.
When you make responsible use of credit, you build positive credit history and good credit scores—two things that can affect other areas of your life, too. For example, your good credit history and solid credit scores can mean that you qualify for better insurance rates, or can open a utility or new mobile phone account with little or no security deposit. In some financial roles, your positive credit history can also influence how a potential employer perceives you, and can recommend your trustworthiness and responsibility to successfully handle monetary functions.
Understanding how credit works
Credit reports and scores
When you ask for credit, whether it's a loan or a credit card, or want to do business with a new company, those businesses will ask to look at your credit report to get an idea of how well you're managing your finances today. Since credit reports include histories of your credit activities, lenders and other businesses will use the information from your past activity to predict your creditworthiness.
They might also review your credit scores, which are numbers, usually between 300 and 850, that serve as a snapshot of your credit status when you apply for credit. The scores are based on information contained in your credit report, and lenders consider it when deciding how likely you are to repay money you borrow.
When you use credit, that information appears on your credit report and can affect your credit scores. Your responsible use of credit can help build your ability to get more credit at favorable rates and terms.
Types of credit
Credit can either be revolving (such as credit cards) or secured (like a mortgage), and these two types of credit have similarities and important differences.
Both types allow you to borrow money and repay it over time with interest. With secured credit, the loan has an end date by which you must repay all the principle (the amount you initially borrowed) and interest. At the outset of the loan, you'll know exactly how much interest you'll pay over the life of the loan. Once you take out the loan, you can't borrow more against that same loan.
For revolving credit such as credit cards, there is no end date for repaying what you borrow. You'll get a credit limit and you can borrow up to that amount, repaying a percentage of what you owe every month. The amount you owe revolves from month to month, and interest accrues every month as well. When you pay down the debt, you'll be able to again borrow the amount you repaid during the next month.
Some common types of credit vehicles include:
- Credit cards
- Auto loans
- Recreational vehicle loans
- Personal loans
- Home equity line of credit
- Student loans
Improving your credit
Because every credit action you take is recorded on your credit report, every type of credit you use has an effect on both your report and your credit scores. When you adopt responsible credit habits and take positive credit actions, you can improve your credit status—and your ability to purchase the kinds of things that enhance your life.
Review your credit report and credit scores regularly, and take steps to ensure that only positive information shows up in your credit history. Good credit-building steps include:
- Paying all your bills on time every month. You can set up automatic payments or payment reminders to ensure you're never late with a payment. Payment history is a significant factor in determining credit scores.
- Paying down credit card and other types of revolving debt. Unsecured credit tends to be more expensive than secured credit, so it's best to keep credit card balances low or at zero. Plus, paying off credit card debt helps build your positive payment history.
- Paying attention to the types of credit you're using. Creditors like to see a mix of some variety so they know you can handle different types of credit successfully. For most people, a good mix of credit will include credit cards, a vehicle loan, possibly some student loans and a mortgage.
- Applying for new credit accounts only when you really need them.
Smart use of credit can make your life better in many ways, so when you take steps to improve your credit, you're also working toward improving your life and getting ready for big purchases to come.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer, or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.