The term “credit” leaves a lot of us scratching our heads. On one hand, we kind of know what it means, but on the other hand, we don’t understand how it works. On one hand, we know our credit needs to be good, but on the other hand, we have no idea how to improve it.
So let’s clear that up with simple layman’s terms:
What is credit?
Credit is borrowed money… a loan. You receive the money (or the item or the service) up front, then promise to repay it back in full, with interest.
What is a credit score?
Your credit score is your reputation with financial institutions for paying back loans. It is a number that financial institutions use to determine how reliable you might be with repayment. Financial institutions rely on credit bureaus to provide your credit report, which includes your credit score and the details of your credit history. There are three main credit bureaus: Equifax, Experian, TransUnion. Each agency will have slightly different details in their credit reports, but there are usually no drastic differences.
What about FICO? What is that?
FICO is a formula for calculating credit scores. The FICO scoring system was created by a company called Fair Isaac Corporation. There are other formulas out there, but the FICO method is the most popular in the US, and all three credit bureaus use it. For all intents and purposes, your credit score and your FICO score are the same thing. FICO scores range from 300-850. The higher the score, the better.
What makes up my FICO score? FICO scores are calculated from five categories. Read this article to see the breakdown. It even uses a pretty pie chart.
I don’t have credit. Is that bad?
Nope. No credit (aka “zero credit”) is not the same as bad credit. It does mean that you may not qualify for many loans until you establish a good credit history. You can begin to build a good credit history by opening a low-rate credit card with low credit limits, a share-secured loan, or getting a co-signer for a small loan. Make your payments in full and on time, and you’ll be on your way.
How do I improve my credit score? There are many ways you can do this. This article is helpful.