Why is Credit Important?

June 29, 2020 | by Jacob Hamilton

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Only around 1 in 8 Americans know what their credit score is. A majority of people make financial decisions every day without a full understanding of what they might mean in the long term. Find out why credit is important to you and how you can better manage yours.

What Is Credit?

Your credit refers to the history of how you borrow and handle debt. Your credit history, which is detailed on your credit report, includes information such as how much you borrowed, how much you own now and whether you pay in a timely manner.

Credit histories are meant to help you and potential creditors. Creditors can look at your history to understand how much of a risk you might be as a borrower. And if your credit is strong, they might be willing to give you a better deal on a loan or other credit.

What Is a Credit Score?

Your credit score is a number that sums up the strength of your credit history. The more problematic your credit history, the lower the score. Your score helps you understand how you're doing with credit and can be a fast way for lenders to determine if they should continue to look closer when considering you for a loan. People often talk about good and bad credit scores. Obviously, higher is better. But you can achieve a lot with a score of 700 or more , which makes those "good" scores.

Lower scores, such as those that fall in the 500s, are much less attractive to lenders. If you have a lower score, you may not be able to get approved for financing—and if you do, the offer might come with a high interest rate. That's why lower scores are called bad credit scores.

What Affects My Credit Score?

Credit scores are calculated using various scoring models, such as FICO or VantageScore. While those models handle the calculations a bit differently, your score is typically made up of five categories of information.

  • Payment history, which is whether or not you pay your bills on time and as agreed. This accounts for around 35% of your score—so paying on time is definitely a high priority!
  • Amounts owed, which is how much of your available credit you're currently using. This accounts for around 30% of your score.
  • Length of history, which is how long you've had credit or had certain accounts. This accounts for 15% of your score.
  • New credit applications, which cause inquiries on your credit report. Too many new applications in a short period of time can be bad for credit because it makes you look like you aren't managing your finances well. This accounts for 10% of your score.
  • Credit mix, which is how many types of credit show up on your report. Lenders like to see that you can manage various accounts responsibly. This also accounts for around 10% of your score.

What Is a Credit Report?

A credit report is an official listing of items in your credit history. Credit reports are kept by the credit bureaus. They're made up primarily of information reported by other entities, such as lenders.

For example, your credit report might include a history of recent loans and credit cards, including details about balances and whether you missed payments. It can also include records about bankruptcy and other financial activity and some information about your employment history.

Why Is It Important to Have Good Credit?

Credit is akin to your personal financial reputation. It's what recommends—or doesn't recommend—you as a good borrower. Having good credit can make it easier to access goods and services and even help make those things less expensive in the long run.

Loans

Many lenders use your credit score to determine if they'll approve you for a loan or not. Good credit typically means more doors are open to you.

It also means that you might save money on better interest rates. For example, if you borrow $5,000 for five years at 5% interest, you pay a total of $5,661.37. If you borrow the same amount for five years at 11% interest, you pay $6,522.73.

The difference between decent and questionable credit in this case is around $1,000—but the cost can be much higher than that depending on loan type and other factors.

Credit Cards

Credit card companies play by similar rules. The best deals—including high-value rewards cards that come with travel or shopping perks—are usually reserved for those with good credit. Your credit also plays a role in how much of a credit limit you're offered and what your credit card interest rates might be.

Employment

Some employers ask to check your credit reports as part of their standard background check. If your credit score is too low or there are a lot of negative items on your report, you could be passed up for a job or promotion. This is especially true if the work involves being in charge of or handling finances or money.

Utilities and More

Insurance companies, utility companies and other providers might run a quick credit check when evaluating you as a new customer. Some insurance companies won't ensure people with credit scores that are very low because they see them as a risk. Other providers might require you to put up a larger-than-normal deposit to start services if your credit is low.

How Do I Build Positive Credit History?

Whether you're looking to build credit history for the first time or add more positive information to yours, there are some best practices to follow. Here are a few tips for taking control of your credit in a positive way.

  • Make all payments on time and as agreed upon. This keeps lenders from placing negative items on your credit history that show you were late.
  • Create and stick to a personal budget so you know what you can afford and are more likely to have the funds to pay your bills on time.
  • Keep credit utilization low. If you have a $1,000 credit card limit, for example, try not to carry more than a few hundred dollars over from cycle to cycle.
  • Don't apply for tons of credit if you haven't been able to get approved. Many applications over a short period of time can bring down your score.
  • Do try to carry different types of credit when possible to help your credit mix. For example, if you have a credit card and an auto loan, you have both revolving and installment accounts on your credit history.
  • Check your credit report regularly and keep an eye on your score so you know if anything changes or if you need to take action to help protect your personal financial reputation.

What Is Credit Repair?

In some cases, your credit score might go down through no fault of your own. If incorrect negative items are reported due to a clerical error, identity theft or even a misunderstanding, they can hurt your credit.

Credit repair is an option for dealing with these issues. Credit repair is the act of reaching out to the credit bureaus and notifying them that the information is incorrect. The credit bureaus are obligated to investigate and remove negative items if they can't be proved accurate. And that can help your credit score in the long run.


Jacob Hamilton Headshot

Jacob Hamilton

GM of CreditRepair.com

With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for CreditRepair.com for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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