Credit is borrowed money that you can use to purchase goods and services when you need them. You get credit from a credit grantor, whom you agree to pay back the amount you spent, plus applicable finance charges, at an agreed-upon time.
There are four types of credit:
- Revolving credit. With revolving credit, you are given a maximum credit limit, and you can make charges up to that limit. Each month, you carry a balance (or revolve the debt) and make a payment. Most credit cards are a form of revolving credit.
- Charge cards. While they often look like revolving credit cards and are used in the same way, charge accounts differ in that you must pay the total balance every month.
- Service credit. Your agreements with service providers are all credit arrangements. You receive electricity, cellular phone service, gym membership, etc., with the agreement that you will pay for them each month. Not all service accounts are reported in your credit history.
- Installment credit. With installment credit, a creditor loans you a specific amount of money, and you agree to repay the money and interest in regular installments of a fixed amount over a set period of time. Car loans and mortgages are two examples of installment credit.
Why Do You Need Credit?
Good credit is necessary if you plan to use credit to make a major purchase, such as a car or a home, or want to be able to take advantage of the convenience credit can provide. The importance of good credit also extends beyond purchases, in that your credit information may be used by potential employers and landlords as part of the selection process.
Credit grantors review credit applications and credit reports to determine financial risk: If they lend you money, extend you credit or give you goods and services, will you pay them back? They may consider your income, how long you've lived at your present address, how long you've worked for the same employer, what kinds of assets you have and the balances of your bank accounts. Often, though, the primary resource guiding their decision is your credit information.