What is Credit

From LoveToKnow Creditcards

Banks, realtors, financial advisors, and car dealers toss the word around casually, but we all need to be able to answer the question, what is credit? Before plunging into the murky world of interest rates, ratings, and scores, it is vital that consumers have a basic understanding of credit to insure that they do not fall victim to its traps.

What is Credit?: A Definition

In its simplest terms, credit is what a merchant extends to consumers based on individual trust. A modern definition, however, would include many different factors that not only influence credit, but also influence that trust.

Modern credit can mean many things, and the phrase “on approved credit” is commonly associated with many types of sales bargains and buy-now-pay-later plans. While most people easily associate credit cards with general credit, those small bits of plastic are only one type of credit. Every type of loan (student loans, mortgages, car loans, etc.) represents additional credit, and each one plays a role in determining the type of credit you currently have as well as what you can receive.

Factors Influencing Your Credit

There are several factors influencing whether or not a company will extend credit to an individual. Most of these factors can be found on a credit report, and they generally include:

Current debt owed
Current annual income
Potential for income stability and growth
Reliability for paying bills and other payments
Unpaid debts including bounced checks or late payments
Speed of increasing credit (how much credit you obtain over a time period)
Legal actions related to finances (bankruptcy, settlements, etc.)

There are many other factors that may also influence the credit a company extends, including the age of the borrower (a very young or very old borrower may be a poor repayment risk), the type of loan sought, and a personal feel for the individual and whether or not they can be trusted, particularly with large, long-term loans.

Getting More Credit

Depending on the circumstances, there are times when it is advisable to obtain more credit. College students are inundated with offers for initial credit cards, and most major purchases (houses, cars, etc.) require some type of credit. In order to qualify for higher credit – and therefore greater trust from lending institutions – an individual must have a decent credit history, or a reputation for paying back loans in a timely fashion.

As interest rates rise, credit card companies and banks are generally reluctant to spontaneously offer additional credit to most individuals. It is possible, however, to contact a credit card company and ask for a credit increase. Approval is not guaranteed. Your request may be denied or an explanation may be required.

While it is possible to simply apply for new credit cards, having too much credit can also be detrimental. A bank will look at all of an individual’s available credit as if he or she charged the maximum amount at once. Lenders judge how well prospective could handle that financial burden before agreeing to additional loans, such as mortgages or car loans. A good rule of thumb is to have 2-3 major credit cards at once, and to be able to demonstrate reliability and trustworthiness with each one in order to qualify for further loans.

Why Understanding Credit Matters

All consumers should be able to answer the question What is Credit? and identify the single factor that most influences it: trustworthiness. Excessive debt, a history of non-payment or late payments, and seeking too much credit are all signs that a particular consumer may not be trustworthy, and they will not qualify for additional loans.

Furthermore, understanding the factors that influence credit can help consumers stay away from credit card fraud, scams, and too-good-to-be-true offers that may result in a shattered credit history that may take years to repair. By being educated about what is credit and what practices create good credit, savvy consumers can build a financial history that opens many investment opportunities for them in the future as well as protects their assets.