Credit is the ability to borrow money: When you borrow money on credit, you get a loan and promise to pay it back with a little extra (interest). Having good credit can make it easier to do things such as:
- Avoid security deposits on utilities.
- Borrow money.
- Enlist in the military.
- Get a job.
- Get approved for a credit card.
- Get better car insurance rates.
- Get better interest rates on credit cards and loans.
- Qualify for a car loan.
- Rent an apartment or house.
A person's creditworthiness is typically measured with a credit score. Your credit score affects your ability to qualify for different types of credit and varying interest rates. In general, the higher your credit score, the better your loan terms.
The most common credit score is the FICO score, named after software developer Fair Isaac and Corporation. A person's FICO scores are provided to lenders by the three major credit reporting agencies – Experian, TransUnion and Equifax – to help lenders evaluate the risks of extending credit or loaning money to people. Lenders typically review the Four Cs when deciding to grant a loan:
- Capacity – your present and future ability to meet your payment obligations
- Capital – the value of your assets and your net worth
- Character – your payment history
- Collateral – the property or assets that will secure the loan
When evaluating the Four Cs, the loan officer may ask questions such as:
- Are you employed? How much money do you earn each month?
- What are your monthly expenses?
- How much money do you have in bank accounts?
- Have you had credit in the past?
- How many credit cards do you have?
- What collateral can you offer?
Unfortunately, we don't start with a clean slate as far as credit scores are concerned. You have to earn a good number, and it takes time. Even when all other factors remain the same, a younger person will likely have a lower credit score than an older person. That's because the length of a credit history accounts for 15% of the credit score. A teen or young adult can be at a disadvantage simply because he or she doesn’t have the depth or length of credit history.
FICO weighs five factors to calculate your FICO credit score:
- 35%: payment history
- 30%: amounts owed
- 15%: length of credit history
- 10%: new credit and recently opened accounts
- 10%: types of credit in use