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Understanding Your Credit
 Jun 08, 2004

Understanding your credit is important. Your credit is your financial history which is reported and scored. In this article we will define what credit is, discuss good vs. bad credit, and provide you with tips on how to build good credit.

In personal finances, probably the most important thing you have to consider is your credit. Credit is the underlying engine of our economy. If you do not have a credit history, it is more difficult to buy expensive items (like cars and homes), and it can even make things harder when you are looking for a job or an apartment to rent. Your credit can even affect what sort of insurance premiums you pay. It is easy to see, then, why credit is an important part of your overall financial picture.

What is credit?

First of all, it is important to understand what credit is. In simplest terms, your credit is your financial reputation. It is a representation to others of how you conduct yourself in the realm of your financial responsibility.

Specific information about your accounts and your financial transactions are kept in your credit history or credit file (sometimes called your credit report). This is a rather large and unwieldy document for lenders, insurers, employers and others to comb through, so the information in your report is often represented by a credit score.

Your credit score is a number between 350 and 950 that is used to easily show your reputation. Different companies use different standards and formulas when putting together your credit score, so it is common for things to line up inexactly between credit bureaus, your FICO score and other scores. It depends on which company is used, and what information that company has, as to your score. You can see why it's important to strive for good credit, though. That way your credit score at all companies will be relatively high.

Good credit vs. bad credit

One of the most important things is to try to have good credit. Good credit offers you all sorts of advantages that bad credit does not. Good credit means that you are more likely to be approved for a loan (especially in this economy) than if you have bad credit. Additionally, some employers will think you are a security risk if you have a poor credit score.

Good credit also means that you have access to the best interest rates on your loans. The interest rate you get can mean the difference of hundreds or even thousands of dollars paid in charges and fees over the life of a loan. When you are getting a home mortgage, a single percentage point difference in interest rate can mean a difference of tens of thousands of dollars in what you pay back overall.

Bad credit limits your choices in terms of credit and other services. You are in no position to demand better terms when you have bad credit. You have to settle for whatever deal someone is willing to offer you, even if it is not the deal that you want.

Building good credit

Whether you have no credit or bad credit, it is important to do your best to build good credit. It is possible to build good credit by paying attention to best personal financial practices. These practices include the following:

  • Paying your bills on time. This is perhaps the most important thing you can do to build good credit. When you make on-time payments, you show that you are responsible and dependable. You show that you will pay your obligations in a timely manner. This is encouraging, and lenders and others see you as less of a credit risk.
  • Paying the minimum amount. The reasons that this is helpful to your credit score are similar to those listed above for on-time bill payment. You want to show that you are capable, on your income, of meeting all of your obligations. If you can pay more than the minimum amount, this is even better.
  • Live within your means. When you live within your means, you are not building up more debt. When you have a lot of debt, and you keep accumulating it, it looks bad on your credit report. It is important to keep your expenses in check so that you show that you are practicing fiscal responsibility.
  • Look for "good" debt. There are different degrees of debt. Some debt, like home mortgage loans and credit cards from major banks, are considered better debt. This type of debt can actually help your credit score, provided you make payments on time and in full. Debt that is viewed as inferior includes such loans as payday loans and department store credit cards.

Your credit is an important part of your personal finances. See that you use it responsibly so that it can aid you moving forward, rather than hold you back.

Related Article: Personal Credit Report >>

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