The Importance of Credit: What It Is and Why You Need It

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If you are looking to make any major purchase or life change, then credit is going to play an important role. So what exactly is credit, why is it important and how can you make sure you have great credit? Here, we will take a look at everything that you need to know about credit.

What is credit?

Credit is your ability to access funds or goods and services. In order to get credit, a lender will want to access your creditworthiness. The most common way that your creditworthiness will be accessed is through your credit score from your credit report. However, there are some other factors that can figure into your creditworthiness:

  • Employment history
  • Income
  • Personal and professional references

Factors that impact your credit

You may be somewhat familiar with the factors that affect your credit. However, it is important that you are well familiar with all the information that is reported on your credit report. Here are the six factors that are included in your credit report that will create your current credit score:

  • Credit age – Your credit age is how long you have had a credit account open. A credit account is usually a credit card or a loan. For an excellent score, you should have an average credit age of at least seven years.
  • Credit usage – Credit usage or credit utilization looks at how much of your credit that you are using. For an excellent score in this category, you will want to keep your credit usage under 20%.
  • Payment history – Payment history looks at how often you pay your bills on time. For an excellent score in this category, you should have an on-time payment history of over 98%.
  • Number of accounts – This category will look at how many accounts that you have open. The more, the better. An excellent score in this category will require at least 10 open accounts.
  • Delinquent notices – Delinquent notices include everything from accounts in collections to liens, evictions and count judgments against you. Ideally, you should have no delinquent notices.
  • Credit inquiries – Every time you apply for a loan or a credit card, a lender will perform a “hard inquiry” on your credit report. For an excellent score, you should limit credit inquiries to no more than one every six months.

Each of these six factors are weighted a little differently when creating your credit score. Here is a look at how each factor is weighted:

Credit Report FactorImpact
Credit ageMedium impact
Credit usageHigh impact
Payment historyHigh impact
Number of accountsLow impact
Delinquent accountsHigh impact
Credit inquiriesLow impact

What is considered good credit?

Now that you know about the factors that create your credit score, it is important to know what score to aim for. If you are looking to rent an apartment, you will want to have good credit. In order to qualify for a home, car or personal loan – with competitive rates – then you will want an excellent credit score. Here is how credit scores are analyzed by most lenders.

Credit score rangeGrading
720 and overExcellent
680 to 719Good
620 to 679Average
580 to 619Poor
500 to 579Bad
Less than 500Miserable

Why do you need credit?

Credit plays an important role in just about every major purchase or life event. Here’s a look at what you will need good credit:

  • Home and car loans – Home and car loans are major financial decisions for both the lender and the borrower. In order for a lender to have enough confidence in the borrower, they will want to make sure that the borrower has excellent credit.
  • Rental applications – A landlord wants to make sure that a future tenant has the ability to pay rent on time. By checking an applicants credit, a landlord is able to access which person has the best ability to pay their rent on time.
  • Job applications – More and more employers are looking at a person’s credit as an assessment of an application’s character and maturity.
  • Credit card application – A credit card company will want to check the credit of an applicant to ensure that he or she will make his or her payments on time.
  • Better financing rates – If you want to get the most competitive rates when it comes to your credit card or loan, then you will want to have excellent credit.

How to repair your credit yourself (The DIY approach)

If you have less than perfect credit, then you will want to take steps in order to repair your credit. Here are some proven steps that you can take to improve your credit:

  • Dispute errors on credit report – Each credit reporting agency (Experian, TransUnion and Equifax) allow you to get a free credit report once per year. Check your credit for any errors. If you see something wrong on your credit report, then dispute it. The creditor has 30 days to respond. If the creditor does not respond, then the error is removed from the report.
  • Pay down high interest debt first – Credit usage has a big impact on your credit report. Therefore, you will want to pay down your high interest debt first.
  • Don’t apply for new credit – Try to avoid applying for new credit cards. Focus on paying down your debt first.
  • Only open secured credit cards – If you need to open a credit card account, then apply for a secured credit card. A secured credit card allows you to use cash as collateral for your credit line.

DIY credit repair vs. a credit repair agency

In addition to repairing your credit yourself, you can also hire a credit repair agency. These agencies can help remove negative information such as liens, collections, foreclosures, evictions and judgements from your credit report. Be sure to carefully check the online reviews of these credit repair agencies before using their services.

Getting the best credit for your life

Credit is important when it comes to just about any major purchase or financing decision. Be sure to monitor your credit often. If you have less than perfect credit, then take the steps needed to improve your credit score today.