Understanding Credit Basics

Understanding the different types of credit, how credit ratings work, and how to manage your credit is essential to reaching your financial goals. And what better time to learn about credit and take control of your financial well-being than National Financial Literacy Month? Let’s break down the basics of credit and set you up for success.

What types of credit are there, and how are they used?

• Installment Loan (Close-End): has a fixed interest rate and set payment amount, usually repaid monthly, for a specific amount of time until the loan is paid in full. Its purpose is typically for auto loans or mortgages, but it also may be used for education loans or to borrow cash.
• Revolving Credit (Open-End): generally, has a variable interest rate (which means it can fluctuate) and has a set credit limit (or, maximum amount that can be borrowed). There’s no maturity date and they typically have a minimum monthly payment amount.

Its purpose is typically for credit or retail cards and home equity lines of credit (HELOCs). Keep in mind that your credit score is weighted heavily on how much of a balance you maintain on these.

• Service Credit: is an agreement to pay for services after usage such as utilities, phone, internet, or streaming services.  These must be paid in full at the end of each billing cycle.

What is a credit score?

It’s a number formulated from information found on a credit report. Lenders use this and other information to determine if they should extend credit to you and at what interest rate. Knowing your credit score is crucial as it significantly affects major life decisions, such as taking out a loan to purchase a vehicle or home.  

What is considered a good credit score?

There are different score models in which one lender may use a different model than another. However, a general range is anywhere between 300–850 and has five typical “rating tiers”:

• Exceptional (800–850)
• Very good (740–799)
• Good (670–739)
• Fair (580–669)
• Poor (300–579)

What affects your credit score?

Your credit score is calculated by five categories with different weights of importance. Let’s learn about each.

• Payment history (35%): is the most influential category and is based on the number of late payments you have and how recent they are (which is why on-time payments are so important to your credit).
• Accounts owed (30%): is the amount of credit you’ve used vs. your credit limits. This can also be referred to as credit utilization.
• Length of credit history (15%): is how long you’ve used credit.
• New credit (10%): is the number of new credit accounts you’ve opened or credit inquiries you’ve had in a given timeframe. Opening multiple credit accounts or having your credit run many times in a short period typically will negatively impact your credit score.
• Credit mix (10%): is the number and different types of credit accounts you have open.

What are some tips to manage or improve my credit score?

• Don’t close old, unused accounts. Keep them active by using them once a year and paying them off in full. Use them for things you already need to buy—even a small purchase works.
• Only use 30% or less of your total credit limit.
• Pay more than the minimum payment; this will lower your credit utilization and help you save on interest.
• You don’t have to do it alone—talk to an expert! We have a team of certificated Financial Coaches who can help you create a budget and strategy to build your credit.
• Regularly check your credit report for any errors. You can access your credit reports for free once a year by visiting AnnualCreditReport.com.¹
• Only take out a loan as needed. Applying for one may require hard inquiries and will likely appear on your credit report for up to two years.²

How can my credit profile help me reach my financial goals?

Think of your credit profile as a report card of your credit history that lenders use (along with other information) to determine if they should extend credit to you and on what terms. For example, if you don’t have much credit history, but you’ve made on-time payments, lenders might decide to extend credit to you, but with a higher interest rate or a lower credit limit.

Your approved interest rate and credit limit may influence your decisions when looking to make  larger purchases like a mortgage, home improvements, and vehicles.

With a little knowledge about your credit and routine monitoring, you may reach your financial goals sooner than you thought! Let’s start with a simple checklist to work on this month.

Credit Checklist:

• Look up your credit score so you know where you stand on the rating scale. This may be done through a free or paid monitoring service, like a financial institution, credit card statement, or third-party company.
• Find out your interest rates on your open lines of credit and how much you pay in interest each month so you can make sure you pay more than the interest you owe.
• Check your credit report and look for discrepancies. If you find any, report them to the three major credit bureaus—Equifax, Experian, and TransUnion.
• Start or cushion your emergency fund. The less you have to use your credit in an emergency, the easier it is to manage your credit score.
• Create or adjust your financial plan to improve your credit profile. If you need help, work with a professional like one of our Financial Coaches.

The bottom line is that credit should be part of your long-term financial goals, so spend this month familiarizing yourself with how credit works, where your credit stands, and how to use credit to meet your goals! And remember, if you need any guidance, make an appointment with our team of certificated Financial Coaches and they will be happy to help.

1 How to Access Your Free Credit Reports

2 What Is a Hard Inquiry and How Does It Affect Credit?