Credit 101

In the coming weeks, we have many topics to cover, some of a more advanced nature, but I view it as appropriate to lay a foundation starting with a basic understanding of credit and how it works. There will be plenty of opportunities in the upcoming block to get into more advanced concepts, finance matrix, finance ratios, credit mix, and various strategies.

Understanding credit is a basic element of financial literacy. It’s very important to understand how it works because if used properly, it can help you; if neglected and allowed to erode, if can cost you missed opportunities and on several hundreds of thousands more over a lifetime.

Credit is a key aspect of your financial power. It helps you to get the things you need now, like a loan for a car or house, based on your promise to pay later. Working to improve your credit helps ensure you’ll qualify for loans when you need them.

There are many types of credit. The two most common types are installment loans and revolving credit. Installment loans are a set amount of money loaned to you for a specific purpose; common examples are student loans and auto loans. Revolving credit is a line of credit you can keep using after paying it off. Credit cards are the most common type of revolving credit.

A credit score is a three-digit number that banks and lenders use to gauge how likely someone is to repay debt. A high score, usually 800 or above, is considered excellent. A lower score, 580 or below, is considered “poor” and will sometimes prevent someone from being able to borrow money, or it may force them to pay a much higher interest rate.

There are several entities and several matrix formulas for calculating credit scores. The most often used score is FICO, or Fair Isaac and Company. According to FICO, there are five things that can impact your score.

·      Payment History (35%)

·      Amounts Owed (30%)

·      Length of Credit History (15%)

·      New Credit (10%)

·      Credit Mix (10%)

The credit bureaus are required to give you a free credit report once a year. The only place you should request a credit report is at annualcreditreport.com.

Your credit score can be used to evaluate home loans, auto loans, credit cards, rental/lease, employment, and insurance. Negative information generally stays on your credit report for at least seven years. Late payments, foreclosures, and collections all remain for seven years, while bankruptcy remains for 10 years. 

The good news is that bad credit can always be improved. Practicing good credit habits can raise a low score, as well as help maintain a good score. Next week we will start talking about those good credit habits and how to implement them. And you’ll be on your way to the score of your dreams in no time.

James Holmes
President, Black Lion Inc.