What is Credit and Why is it Important?
Credit is the ability to borrow money or access goods or services with the understanding that you'll pay it back later.
Lenders like credit unions, banks, merchants and service providers are known collectively as creditors. Creditors can grant credit in the forms of loans, credit cards, service contracts and more. They grant credit based on their confidence that you will pay back what you borrowed, and any additional fees, in a timely manner.
Creditors will base their decision on your credit score. Most credit scores range between 300 and 850.
Credit scores are separated into the following ranges:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very good
- 800-850: Excellent
Credit scores are generated using the FICO model. The FICO model was introduced in 1989 by Fair, Isaac and Company, now Fair Isaac Corporation (FICO). It is the most widely used credit score model in North America and is used by the three main credit bureaus: Experian, Equifax, and TransUnion.
Credit bureaus are basically data collectors or credit reporting agencies. Credit bureaus and creditors allow each other access to your credit history, also known as your credit report. When applying for a loan or credit card, the creditors will refer to your credit score provided by a credit bureau. Since each credit bureau uses its own formula, your FICO score can vary, depending on which bureau supplies the information. However, your credit score will typically remain in the same range.
Your credit score is generally calculated based on the following aspects of your personal credit report:
- Payment History (35%): Making payments on-time boosts your score.
- Capacity (30%): The less you use of your total available credit each month, the better! Your score can decrease if you get close to your maximum credit amount -- even when you're making payments on time.
- Length of Credit (15%): A longer history of good credit raises your score.
- New Credit (10%): Opening new credit cards (even credit cards from retail locations) can have a short-term negative effect on your credit score.
- Mix of Credit (10%): A mix of revolving credit (credit cards) and loans (like mortgages or car loans) boosts your credit score.
Why is having a good credit important?
Credit scores are used to determine your credit trustworthiness for more than just loans. Landlords, employers, utility companies and insurance companies may all check your credit score before deciding to offer you an apartment, service or job.
If you're looking to improve your credit, Southland has resources for you!
- Take the 5-minute financial course called Credit Scores and Reports.
- Watch short videos to review the basics on using credit (these are great for teens and young adults, too!).
- Read articles provided by credit bureau and Southland partner, Experian.
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