Understanding Credit

What is Credit?

When a lender or other financial institution refers to a person's "credit" they are referring to that person's ability to borrow money. You may have heard the terms "good credit" and "bad credit", or even a third category, "no credit". Generally speaking, a person with "good credit" has the ability to borrow more money than a person with "bad credit". A person with "no credit" is a slightly special circumstance.

Dealing With No Credit

An individual who has never borrowed anything at all is said to have "no credit", or in other words, no ability to borrow money. The reason this is true is that before a financial institution will loan a person money, they must make sure that the person is trustworthy, that there is a good chance that the individual will pay back the money that they have been loaned. If you are a consumer that has never borrowed money before, you have no "proof" that you will pay back a loan.

Having "no credit" does not immediately mean that you will not qualify for a loan, it just means that you will probably not qualify for the best interest rates. As an individual with no credit, it is important to start building your credit slowly and responsibly so that you don't get in over your head, and are able to prove that you can be trusted to repay the money you borrow.

Bad Credit

A person with bad credit is one that has been extended credit in the past, but who has been unable to repay their loans, or keep up with their other financial obligations, (such as utility bills or parking tickets). Because their history indicates to lending institutions that it may be risky to loan money to them, often times individuals with bad credit are only able to obtain loans with high interest rates or unattractive terms. Bad credit can be repaired over time, if the individual re-establishes a consistent and positive payment history on their financial obligations.

Good Credit

Of the group, good credit is obviously the most difficult to maintain. For your credit to be considered "good", you must not only make sure to stay on top of your financial obligations, you must also have financial obligations. You can't have good credit if you have none at all, so to build a positive credit history, you need to apply for credit, such as credit cards or vehicle and home loans. Once this credit is granted to you, it establishes what is called your credit limit, or the maximum amount of credit you are allowed to have. As you show yourself to be responsible by paying back your loans and keeping your credit card balances paid off, your credit limit will increase. In the beginning, your limit will be small, and you may not be able to apply for a lot of credit, (a home loan for instance), but over time your good credit will build, and you will be able to make larger purchases on your credit.

The subject of credit can be a tricky one, and it helps to have as much information about it as you can before you move forward in to making serious financial decisions or large purchases that may effect your credit. By reading the articles in this section, you will be able to increase your understanding of the topic of credit whether you are establishing, rebuilding, or maintaining your credit.