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Starting simple: credit basics to get you going
Swipe, insert or tap. Click, sign and repeat. You’re probably no stranger to using credit. But if you find yourself feeling like you don’t really understand it, read on to cut through the confusion and learn the basics. Who knows? You might even find a new friend in this trusty tool known as credit.
What is personal credit?
“Credit is an agreement between a borrower and a lender, and this includes the promise that the borrower will pay the money back at some later date, usually with interest,” explains Vanessa Owens, Community Mortgage Sales Manager at TD. In other words, you get a way to pay for something now, then don’t have to worry about paying that borrowed money back until later. (How convenient is that?)
Think big (and small) when it comes to credit
“While credit is important to establish, you have to establish good credit because this may help you to qualify for lower costs to borrow, higher credit limits and potentially obtain favorable terms when you’re renting,” says Owens. A good credit history may have an influence on everything from interest rates to cell phone contracts. Plus, it can spare you some stress when it comes to your finances.
Need even more motivation to get your credit in check? “Many employers look at your credit report,” says Owens.
Showing lenders your worth—creditworthiness, that is
Creditworthiness: this 16-letter word boils down to one concept. “It’s how the lender actually determines if the bank will extend credit to the borrower as well as how they assess the borrower’s ability to repay,” Owens explains.
Lenders look at things like your repayment history and credit score to see how likely you are to pay the money back. Reliable borrowers can get perks like lower interest rates—but don’t sweat it if your credit report says you're not as “reliable” as you’d like just yet. Your creditworthiness is always changing, and you can improve your status by making payments on time.
Three credit types calling your name
The three types of credit are important because they impact your credit report and credit score. Your credit report is a statement documenting your credit activity and current credit status. Your credit score predicts how likely you are to pay a loan back (and on time). A higher score shows lenders that you tend to manage credit responsibly. There are lots of other ins and outs of credit to get familiar with, but those two terms are the big ones.
Got those down? Then you’re ready for the three main types of credit out there—and you’re probably already using them.
- Installment credit: Think loans, like for a car or home. This type of credit is “a closed-end account that’s paid back over a set time period with a set number of scheduled payments,” says Owens.
- Open credit: Credit cards and lines of credit are perfect examples, even if you carry a balance. Open credit “allows you to access credit repeatedly over time, and as you pay that credit becomes available again.”
- Revolving credit: Have a credit card? Congrats. You’re probably already a pro at this type of credit. “Each month you carry a balance, continue to make payments and make charges up to a set limit,” Owens says. Carrying over that balance is what turns credit cards into revolving credit, and you can keep spending up to a certain amount as long as you make the minimum payment.
How to hit the ground running
Establishing credit is a whole other story, but in the meantime, here are a few tips to get you going.
“Becoming an authorized user may help you get good credit on your report without actually having to go out and apply [for a credit card] yourself,” says Owens. Get a trusted friend or family member to help you with this.
Another option is getting a secured credit card, where you put down a security deposit that acts as your credit line. You’re basically borrowing from yourself, and it helps boost your score. (Neat, huh?)
“Get a secured card through your bank, so that you can show a line of credit on your account and use your own money to pay for it. Use it for things like gas, and pay if off every month, so you’re generating a score without adding any additional debt,” says Owens.
Whatever you do, “Make sure you pay your bills on time,” Owens says. Keep your credit in check by paying down debt consistently. Master this skill, and you’re well on your way to establishing that credit.
Even if credit isn’t your new BFF now, understanding these basics can help set you up for a mutually beneficial relationship, secure your financial freedom and maybe even make your life a little easier in the long run.
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This article is based on information available in February 2022. It is for general informational purposes only. It is not intended to provide specific financial, investment, tax, legal, accounting, or other advice and should not be acted or relied upon without the advice of a professional advisor. A professional advisor will recommend action based on your personal circumstances and the most recent information available.