All About Credit: What is it and what does it mean to you?

For the next few weeks we’ll be taking a look at the sometimes mysterious world of credit: what it is, how it works, why it’s important and what’s changing.

Put simply, credit is your ability to borrow money. It could be a smaller amount, such as paying for your new cell phone over 12-24 months. It could be a car loan that lasts a few years. Or even a mortgage that will take you 30 years to pay back.

As an aside, the (very) old school thought that debt is bad is way off base. Debt that helps you buy an asset such as a home, or make an investment in yourself or your child, such as paying for college, is debt that generally makes sense.

Running up a credit card balance to pay for a vacation you really can’t afford, or expensive clothes you don’t need? Not a great idea. Your tan will be long gone but you’ll still be stuck paying for it (and probably at a high interest rate). 

Used responsibly, debt can be a tool to help you achieve your financial goals, making it an important part of your overall financial plan.

Are you a good risk?

Lenders, such as banks or auto dealers, have one question: Will you pay back your loan in a timely fashion? Or, put another way, are you a good credit risk?

Generally, the way they judge that is by looking at your credit report and credit score. Your credit report shows your history of paying back loans and other financial obligations. Did you make all of your payments? Were they on time? How far back does your credit history go?

Your credit score boils your credit total history and current debt situation down into a single, three-digit number. That number can govern:

• Whether a lender will give you a loan
• The interest rate you’ll pay on that loan
• Your ability to qualify for a credit card
• Your ability to rent an apartment

In many states, a poor credit report can even mean being turned down for a job, if the employer thinks a poor credit report indicates a lack of responsibility.

Your credit score

You’ve probably heard of the FICO score, normally a number between 300-850. You may have even heard of another financial risk scoring system called VantageScore, which uses the same scale.

FICO, which began as Fair, Isaac and Company (its two co-founders) recently announced significant changes in its analytics model. They estimate that about 40 million Americans will see their scores rise, and an equal number will have lower scores.

What will that mean to you, how can you build healthy credit habits, and how can those habits help you reach your financial goals? Keep watching this space to learn more.