What is credit and why do credit scores matter?

In this introductory post we’ll explore the basics of credit: what it is, how it’s used, and why you should care about yours. Your credit score is essentially a numerical representation of your credit history and profile, so we’ll cover credit score basics as well.

What is credit?

Put simply, credit is just the ability to buy things now and pay for them later. The strength of your credit determines how much you can buy (also known as buying power), and your credit score is what tells banks and other lenders how strong your credit is. It’s the main thing they use to determine whether they should lend you money at all, and if so, how much and at what interest rate.

What is a credit score and how does yours impact you?

The tricky thing about your credit score is that it’s not “yours” in the same way that your other possessions are. Instead, it’s more like your reputation–it’s attached to you, it follows you around, and sometimes people know about it before they actually know you. You can influence it with your actions and habits, but it is also dependent on how other people (or in this case, banks and lenders) perceive those actions and habits, and what they say to each other about you.

The main reason why you should care about your credit is that credit is your ticket to unlocking greater buying power through credit cards, loans, and other financial products that you may need in order to buy a car, a house, an education, or whatever else you want (and can afford to repay).

On the flipside, the main reason that banks care about your credit is that, for them, it is the best, and often the only, way for them to decide whether or not to lend you money without doing an in-depth audit of your finances. It also determines how much they will be willing to lend and how much interest they will charge you on the amount you borrow.

Over time, you can help your credit by consistently paying lenders back on time, and you can hurt your credit by paying late or never paying them back at all. This pattern of payments made over time is the primary driver of your credit score (35% of your score, according to FICO).

Your credit score is used by lenders to make a quick judgment about how much money to lend to you, as well as how much to charge you for the credit they offer (generally in the form of interest, and identified on card applications and statements as your APR).

If you have a high credit score, lenders (usually banks) will trust you a lot, so they will lend you lots of money and only charge you a little interest. If you have a low credit score, lenders won’t trust you to pay them back, so they will only lend you a little money, and they will charge you a lot of interest.

How does one build up a good credit score?

The main thing to remember about credit and credit scores is that consistency is key. To reiterate, payment history makes up 35%, or roughly one third, of your overall credit score. (To see what the other factors are check out our post on the Anatomy of a Credit Score)

In order to build a great credit score and have lots of credit available at the lowest possible rates, you have to pay on time, every time, not just for a few weeks or months, but for years and decades.

Those with the highest (“super prime”) credit scores have literally hundreds, if not thousands, of on-time payments across all of their credit accounts, made consistently over a decade or more.

In order to build robust credit and obtain the high scores that come with it, you’ll need to understand what type of credit accounts are out there, how to apply for and use them, and how to make sure you keep them all in good standing over time. And we can help! Check out Credit Cards 101 to get started with the most easily accessible type of credit account for most people: credit cards.