What is Credit?
Credit is money that you borrow in order to buy something you want or need today. When you receive credit from a lender, such as a bank or credit union, you promise to pay back the amount you borrowed (i.e. the principal), plus additional interest. Your ability to pay the creditor back in time determines your credit score.
Types of Credit
When you borrow money, there are four different ways to go about the process:
- Revolving credit: The lender gives you a maximum credit limit, and you are allowed to make payments up to that amount. You carry a balance each month and you can either pay off a portion or the total amount of the balance.
- Charge cards: Charge accounts are similar to revolving credit. However, charge accounts do not have a predetermined limit and the credit limit is determined by your credit history.
- Service credit: With service credit, you will form a credit agreement with your service providers, such as your cell phone service provider. You promise that you will pay them each month.
- Installment credit: For an installment credit, you are loaned a certain amount of money, and you agree to pay back the principal plus interest in fixed, recurring payments over a set period of time.
Why is Credit Important?
Having good credit is necessary and helpful. It plays a role in many important life situations including:
- Making large purchases for items such as a car or house
- Credit checks conducted by landlords or employers
- Determining interest rates when borrowing from a lender