The textbook definition of credit according to Experian, is borrowed money that you can use to purchase goods and services when you need them.
You get credit from a credit grantor, whom you agree to pay back the amount you spent, plus applicable finance charges, at an agreed-upon time.
Now while this is the accurate definition, it still doesn't quite explain it to you in "Plain English.
In "Plain English" - Credit is money that someone (like a credit card company) lets you borrow to buy things that you may or may not need.
To borrow the money, however, you must promise you will pay them back, on-time, and sometimes with interest.
It is essential to understand that credit is all about your level of responsibility and reputation.
You are giving your "Word" that you will pay back whatever you borrow.
There are four types of credit that you can borrow:
Revolving credit works how it sounds, it gives you the ability to "revolve" your debt.
Let's say you are given a set credit limit like ($15,000) and you spend the full amount.
With revolving credit you get to pay a much lower monthly fee and carry the balance monthly until you have paid back the entire amount.
This gives you the ability not to have to worry about paying the entire balance in 30 days. Almost all credit cards are a type of revolving credit.
You also can continue to use the card once you have paid the balance down.
These cards look the same as traditional revolving credit cards and are used in precisely the same way; however, the difference comes in when it's time to pay up, you only have 30 days to pay the full amount.
Let's use the same example from above, you have a $15,000 credit limit that you maxed out on your charge card, you will only have to the next billing cycle (usually 30 days) to pay this balance in full, or it will be considered late.
You also get to continue to use the charge card once you have paid the balance down.
Installment credit is a bit different from the above types of credit in it is only a one-time use product, you get a set amount (like $15,000), and you are given a payment schedule.
This schedule will show you how much you need to pay over a set period to pay back the money, once the installment is paid back, that is the end of the agreement.
A car loan, personal loan, and a mortgage are examples of installment credit.
Service credit is less thought about than the other types of credit.
However, things like your Netflix Account, Amazon Prime, your electric bill, or cell phone plan are all types of service credit.
Most service credit items do not report to the credit bureaus so they won't be on your credit history.
However, very recently, companies are taking a stand and trying to get utilities and services included on your credit report to help your score.
Now that we have discussed the type of credit let's look into who the primary credit bureaus are.
What Are Credit Bureaus?
When you apply for any type of loan, get approved, and use your credit, the places that are keeping track of this process are called the credit bureaus.
Think of them as the third party that is holding you accountable for giving your word to a lender.
The collection of people you have borrowed money from and how you have managed that borrowed money is your credit report.
Several sites allow you to check your credit; however, all of their data is pulled from the credit bureaus.
While the primary bureaus are Experian, Equifax, and Transunion, others exist such as Early Warning Services.
I first heard about Early Warning Services when I opened my account with USAA.
There is also Chexsystems, they collect information on your checking account applications, the opening of accounts and closure along with the reason for the closure.
Almost every bank will run this check to make sure you don't owe money to another bank before they open an account for you.
The Consumer Financial Protection Bureau has a complete list of credit reporting agencies here (PDF)
Credit Lingo You MUST Know
Before you can start building or establishing your credit, there are a few terms that you need to know about and you also need to understand how they work to get the most out of building your credit.
What Is A Credit Report?
Your credit report is like a report card, but instead of showing grades, it gives you and potential lenders an overall picture of your reputation and responsibility with other lenders.
This report is going to show several things like:
All Of Your Accounts - You can view all of your accounts that are open or closed on your report.
Account Balances - You can see any balances you owe.
Credit Limits - It will show all of the credit limits for each account.
Your Payment History - It will show if your payments are on-time or if they are late.
Average Age Of Accounts - This shows lenders how long you have been using your credit.
Hard & Soft Inquiries - A list of anyone who has pulled your credit report.
Below is a quick shot of how a credit report looks:
You can review the entire sample report here (PDF)
What Is Your Credit Score?
Your credit score is a numeric number between 300 and 850 or 250 and 900 depending on the scoring model being used that is determined by your credit report.
The most important credit score in 2019 is going to be your FICO score, this score was created by Fair Issac Corporation and is used by over 90% of all lenders.
This means that if you are looking at a credit score that doesn't explicitly say it is a FICO score, then it's pretty useless.
To be on the safe side, you can just go to Myfico.com.
Now, I don't mean to offend the other scoring models, but lenders don't use them.
This means if you use Credit Karma and get your credit score, it won't be the same score as your FICO score.
While you think you have a 650 credit score, the ones the lender will see could show you have a 600 FICO credit score.
A lower score is going to mean completely different lending terms when it comes to credit.
Below is a breakdown of the critical factors that make up a score:
The above chart shows you what the most critical factors are on your credit report that will make up your credit score.
As you can see, Payment History and Credit Utilization are the most critical factors and the ones you can most control.
What Is Credit Utilization?
Credit utilization is all about how much of your credit you are using compared to how much is available.
When it comes to credit, the lower the utilization being reported on your credit report, the better.
If your first credit card has a $1,000 limit and you haven't used it, your credit utilization for that card is 0%.
If you spend $500 of the $1,000, then your credit utilization is now 50%.
It is recommended that you keep your utilization for both your cards and complete credit profile below 30%.
I can't stress this enough, to make sure your profile is growing you need to request credit limit increases.
A credit limit increase is much better than trying to get approved for another credit card at a higher amount.
If you follow these steps, within 30 to 60 days, you should see a massive change in your profile.
We challenge you to join our Co-founder Mark in our Free 30 Day Credit Sprint.
How Long Does It Take To Build Credit
How long it takes you to build your credit is going to depend heavily on your goals and what it is that you are trying to obtain with credit.
When you do anything such as adding new tradelines or paying down a bill, it still will take 30 days for it to be updated to your credit report.
Below is a timeline to give you an idea of how long it can take to build credit
During the first 30 days of establishing your credit don't expect to see anything.
Most of your accounts still wouldn't have hit your credit report, and you probably don't have a credit score.
You will have a few inquiries on your account immediately, and those will hurt you in the short term.
Once your first 30 days are up, you will start to see a change in your credit profile.
At the 60 day mark, all of the accounts you applied for should be on your credit report, and you should also have a credit score established.
This score might not be high starting out, but that is perfectly fine, we are going to build it up.
As long as you have paid your bills on time and kept your utilization low, you should be able to qualify for some sort of credit limit increase with a soft pull.
After 90 days you really can start to see your credit report & score take off because you probably have higher credit limits, your accounts have aged for 90 days, and you are still paying your bills on time.
If you haven't done any credit limit increases, at the 6-month mark, you definitely need to be requesting one.
You are probably going to see your score has increased drastically as long as you are keeping your credit utilization low, and paying bills on time.
After your accounts have aged for 1 year and you have kept up with reasonable payments, made a few credit limit increase requests and kept your utilization low, your score will be substantial.
After 1 year, your next goal should be to add more tradelines, over 20 is the suggested amount of accounts to have.
Your initial credit inquiries would no longer be counted in your FICO score after the first year either.
However, they will still show up on your credit report.
You should also be able to qualify for that car or that home based on your credit profile.
If you don't mess up, your credit will keep going up and getting stronger.
Time Is The Only Constant
So, to be perfectly honest, in about 1 to 2 years if you follow the outlined steps above, you will have a firm credit profile and score.
The one thing you can't change in the credit space is how fast something will update so once you have done the work, you just have to hurry up and wait.
How To Build Credit Without A Credit Card?
When looking into building your credit, credit cards have been one of the go-to staples.
However, there are other options that you should consider outside of credit cards start building your credit.
We list some other alternatives below that will work great for building credit:
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Credit Knocks, LLC doing business as Credit Knocks is an independent, advertising-supported, information and review service. Some of the offers that appear on this site are from companies from which Credit Knocks receives compensation. All financial products and services are presented without warranty. When evaluating offers, please review the financial institution’s Terms and Conditions.
Credit Knocks is an independent, advertising-supported, information and review service. Some of the offers that appear on this site are from companies from which Credit Knocks receives compensation. All financial products and services are presented without warranty. When evaluating offers, please review the financial institution’s Terms and Conditions.