The Basics of How Credit Works
While credit is an important part of your financial life, you may not fully understand what your credit history is and how it works. Understanding the credit reporting system is key to monitoring and managing your finances the right way. So, let’s start with the basics.
What is credit?
Credit is an agreement that a borrower makes with a lender or finance company to obtain goods or services that are later paid for by the borrower under agreed-upon terms. To put it simply, credit is borrowing money and paying it back – in most cases, with interest — over time. For example, if you’re shopping for a car, you might get a car loan or auto financing (credit) to purchase your vehicle. If this is the case, you’ll need to make monthly car payments along with interest and possibly other fees, depending on the agreement.
There are two different types of credit:
- Revolving credit, which allows consumers to borrow money up to a certain limit when they need it, using either a line of credit or credit card.
- Installment credit, which is when the lender or finance company extends a large amount of credit upfront, and you agree to repay the debt in regular installments over a fixed period called a loan or financing term. Installment credit includes car loans or financing, mortgages, student loans and personal loans.
Whether you’re using revolving or installment credit, making on-time payments every month can have a positive effect on your credit history, which we’ll get into next.
What’s your credit history?
Your credit history is a record of your borrowing and repayment activity (how you’ve used credit). This includes:
- The number of credit cards and/or installment credit accounts you have
- The number of on-time or late payments you’ve made
- How long you’ve had open credit accounts
All this information can be found in your credit report, which is provided by each of the three major credit bureaus—Equifax, Experian and TransUnion.
What’s in your credit reports?
Your credit reports provided by the three major credit bureaus consist of your personal information and a documented record of your credit history. Information makes its way into your credit reports when lenders and finance companies report your account activity to any of the three credit bureaus.
So, how can you build a positive credit history?
- Pay your bills on time, every time.
Making on-time payments is a surefire way to improve your credit history and build good credit. A good way to ensure your payments are on time — every time — is to set up automatic payments and/or electronic reminders. - Keep your credit balances low.
Experts advise keeping your use of credit at no more than 30 percent of your total credit limit. - Use credit wisely.
Taking on too much debt can make it more difficult to keep up with your payments, which can have a negative impact on your credit history. - Check your credit reports.
Errors found in your personal information or account activity can have a negative impact on your credit, which is why you should check your credit reports regularly. You can get a free copy of your credit report from Equifax, Experian and TransUnion every 12 months at annualcreditreport.com.
Are you someone with bad credit or no credit who needs help getting approved for financing to purchase a vehicle? Credit Acceptance can help you find up to three car dealerships enrolled in its program near you by filling out our pre-qualification form on our website.
Click here to begin your online pre-qualification process
