What is Credit?
You hear the term almost everyday in a financial point of view. The word itself is used in different ways when talking about money. So tell me; what is credit?
Credit is a financial tool that provides the power to buy things that you may not have cash to pay for at the time of the sale. No matter what method (credit card, loan, etc.) you use to pay for the item, it is all credit for you to use. And how much "credit" you have will depend on your ability to be responsible with your debts and repay your creditors (those that provided the funds for you to make purchases) within the timeframe established. The more responsible you are, the more credit you will have in the future. Because of that, it is important for you to build a strong credit history and work at keeping it that way.
Creating Credit History
To help you build a strong credit history, you need to understand what makes your credit strong. As was mentioned before, financial responsibility to pay off creditors within an established time frame will do it. But that isn't the only factor involved. Consider your employment history as a factor in creating a strong credit history. Why? Think about it; if you have a history of unemployment, you are a risk for not being able to fulfill your debt responsibility if you are given a loan. . .even if you are employed at the time.
And let's say that you are employed – and let's add to that supposition and say that you don't have a history of unemployment – you still may not be able to secure loans. Securing a loan will depend on your ability to pay it back. The fact that you are employed doesn't grant the loan by itself. . .the salary you earn will also have an effect.
Summed up, you start building your credit history by being employed with a salary that will allow you to pay back loans and showing that you can be responsible about it.
At one point in your life you had no credit history. Maybe you still don't. So how do you start? You start by getting a loan. It can be a loan in the form of a credit card, or a loan from a financial institution for a car or schooling. Without a credit history that shows previous lending and payoff taking place, they will have to rely heavily on your employment/income. If you are applying for a credit card, the card issuer will ask how much money you make. They will also run a credit report on you to see what your credit history is like. Since you don't have any credit history, they will consider you more of a risk. This doesn't mean that you will be denied the card. What it does mean is that you will most likely have a smaller spending limit on that card and a higher interest rate.
After a review of the information you gave the card issuer in your application, they decide to grant you a card with a $1000 limit and 23.9% interest rate. Congratulations. . .you now have some credit history. You don't have a lot of spending power yet, but you have credit history. Also, you will now have a credit score, which will be an additional factor in securing loans in the future. (To better understand credit scores, read the article entitled "Your Credit Score.")
The Effects of Credit
There are a lot of people that learn what has already been discussed in this article about credit but still don't realize what it does for you and what it can do against you. Let's look a little deeper so that you have a clear understanding how serious you need to be in establishing a good credit history.
Credit isn't just about getting a loan. As mentioned at the beginning of the article, credit is proof of your financial responsibility. It is a sign of how trustworthy you will be with someone else's money. It is also one of just a few things that will either make your life really good or really bad.
Credit history is being used for a variety of things today. When you want to rent an apartment, it is likely that the landlord will run your credit history to determine if you will pay rent each month or be a deadbeat tenant that will end up being evicted. The landlord is justified in wanting to know this information – it costs money to have someone evicted because of legal fees. That expense plus the loss on rent could be more than the landlord can afford so he will look at credit histories to get a tenant that poses less of a risk.
Insurance agencies take the same approach – with a twist. They too don't want to have a customer that poses a risk of not making the monthly payments. But here's the twist: insurance companies can charge you a different rate than somebody else just because you have a credit history and score that is not as good. They will tell you that as your credit history and score get better (you know, just make consistent on-time payments for two years. . .or something like that) the insurance rate will go down. They are justified in their own way, whether it is right or wrong to do. Their justification? If you can show that you are responsible and trustworthy with your credit, they will assume that you are that way in all walks of life. That translates in their minds as someone who is not reckless in making decisions, someone who will be a better driver, someone who will take care of their car, etc. If that is what they see in you, they will be happy to have you as a customer for auto insurance and you will get one of their lower rates.
Employers are starting to get into the game of credit checks for employee candidates. Many times as an employer is trying to decide whether or not to hire an applicant they will run a background check. These background checks are most often checking the criminal history of the applicant. Sometimes, however, the check will include a look at your credit history. They will use the same justification as insurance agencies as well. Basically they want to see if you are responsible with your money. If you are, you will probably be responsible with the rest of your life. And if the position that you are seeking is one that requires travelling, the employer will be able to see if you will be responsible with their money too.
Do you understand now why your credit history can make your life really good or really bad?
Continuing to Build Your Credit
As you continue on throughout life you will continue to create credit history. Whether that history is good or bad will depend on you. It is likely that you will have other opportunities to secure loans for one reason or another. Be responsible with them and your credit score will improve. One thing that you may consider while your credit history is young is to have a relative or very good friend with a good credit history co-sign on a loan with you. This most commonly happens with teenagers or college students that want to purchase a car. Having a parent with a long-running, good credit history co-sign on a car loan "lends" their score to the child. This means that lower interest rates and higher loan amounts are possible.
It also means even greater responsibility. If the child is the one making the payments and they are late, both the parent and the child will have some negative marks added to their credit history and scores. On the flip side, if the child makes the payments on-time each month, they are strengthening their own credit history. It will be easier for them to get other loans in the future and reap the benefit of lower interest rates.
One thing to avoid, however, as you build your credit history is trying too hard to establish your credit by applying for loans or credit cards too frequently. This is actually a bad sign to creditors. The solution? Maintain control of your spending. If that $1000 credit limit on the credit card is too small for you, use the credit history you have established and see if the card issuing company will increase your limit. Ask for a decrease in the interest rate too. If they don't want to lower your interest rate or increase your spending limit, don't use that as an excuse to close the account. You have credit history now and should be able to get another credit card with better terms, and feel free to do so. Just don't overdo it. You don't want to have too many cards or it starts to look risky again.
Also, if you do get a new card, don't close the account on the first card just yet. One more criteria to a strong credit history is longevity. If you get a new card with a lower rate and higher limit, make sure to pay off the first card. Then you can let it sit. Don't use it if you don't want to. Just don't close the account. Ten years later in life when you need a mortgage loan, the lender will run a credit report on you and see that you have maintained an account for over ten years in good standing (because you didn't use it during the last ten years. . .) and this will show favorably for you. You do benefit by keeping a credit card account open even if you never use the account. But again, you need to be responsible. Don't have ten credit card accounts open and inactive thinking it will help your credit history because it won't. If you have a lot of credit cards, close the accounts for the youngest in age that do not get used.
Continue to Be Educated
There is so much more to be learned about obtaining credit than can be included in this article. There are two more articles that will help with this education: "Using Credit Wisely" and "Your Credit Score". Read them for additional help. Also, search the internet for information. You will find a lot to help your credit.