You need good credit, but what is credit? In order to improve your credit you need to know how credit works, what hurts it, and how you can manage it. Let’s look at what credit is, how it works, and where to find out more about it.
What is Credit?
Credit is your reputation as a borrower. It tells others how likely you are to repay your loans. Credit is made up from information about your borrowing history. Most of the information comes from your credit reports.
What is a Credit Report?
A credit report contains information about your borrowing history. Lenders (and others) provide information that ends up on credit reports. They report how much you’ve borrowed, how you’ve repaid, and other details about your borrowing behavior. Your credit report is the master document that's behind your "credit."
When somebody wants to see your credit report, they request one from a credit reporting company - or "credit bureau."
What is a Credit Bureau?
Credit reporting agencies collect all of the information that appears in your credit report; they are information warehouses, but they might not keep as much data as you think. Again, they get that information from lenders you've worked with, public records databases, and other sources. They distribute or sell that information when you apply for a loan or when a company wants your information.
There are numerous credit bureaus, but the "big three" have the greatest impact on what is most often referred to as your "credit." It's essential that the information is accurate - if there are errors in your credit reports, they need to be fixed or you'll be rejected for loans (and it could affect your life in other areas such as applications for jobs or insurance).
For more details, see How Credit Bureaus Work
What is Credit Scoring?
Credit bureaus have a ton of information. There are hundreds or thousands of lines of information about you in their databases, and it’s difficult for lenders to sort through all of it. As a result, most companies use credit scores instead of reading through everything in your credit reports.
Credit scores are numbers generated by a computer program that reads through your credit reports. It looks for patterns, characteristics, and red flags in your history. Based on what the program finds, it spits out a credit score.
What is Credit Used For?
Credit was originally used for lending decisions. Nowadays, credit scores and reports are used in other areas of your life. Consumers and lawmakers constantly watch what credit is used for, and debate about the fairness of credit scoring and the expanding use of those scores.
In addition to lending decisions, credit is used for insurance and employment approvals.