There are a few different definitions for credit, but for our purposes, credit is related to borrowing money. Credit is the amount of money a person is approved to borrow, accessible immediately and repaid later. It is important to note that a persons’ credit history, also known as their borrowing reputation, affects the amount they can borrow, their chances of approval and the interest they will be charged.
How Does Credit Work?
A potential borrower applies for a loan, and if approved, a credit account is established. Prior to approving, a lender reviews specific criteria including the borrower’s credit history to determine the applicants’ ability to repay the loan.
If the lender approves the application the terms of the credit agreement (including repayment term, interest rate charged and all fees) are documented and signed by the applicant. The applicants’ signature serves as their intent to repay the loan as agreed.
Depending on the type of credit account established once approval is granted the borrower has access to the funds.
What is a credit report?
A credit report is a detailed summary of a persons financial and credit history. Included in a credit report is identifying personal information, a credit score, current and past employers, the SIN or Social Security number, types of accounts previously established with lenders (mortgage, personal loan and credit cards), the date each account was opened and related payment history, which includes any missed and late payments. Credit reports are maintained by a credit bureau, or credit reporting agency, and used by lenders to determine the likelihood the applicant will repay the debt.
What is a Credit Score
A credit score is a 3 digit number (typically between 300 and 900) that indicates how likely a person is to repay their debt. A persons’ credit score is calculated using information from their credit report. Credit Unions, Banks and other lenders use a credit score when deciding on loan approval, the loan amount and the interest rate charged for the loan.
Why is Credit Important?
Most people at some point in their lives will need to borrow money to make a major purchase such as a home or a car. Credit makes these major purchases accessible for the average person, as most don’t have a few hundred thousand dollars available to buy a house. Rather than having to hand over all of the money up front, the use of credit spreads the burden of the cost over a longer period of time. Credit is very handy tool and it is important to establish and maintain good credit.
Types of credit
The two most common types of credit are installment loans (mortgage, car and personal loans) and a revolving credit account (credit cards and a line of credit).
There are also two main categories of credit:
- Secured CreditThe borrower offers up a specific asset (a car, a home or money) as security for the loan. The asset is forfeited if the borrower does not meet their repayment obligations and defaults on the loan. Most major lenders offer Secure Credit Cards for people with less than good, or, no credit history.
- Unsecured Credit Funds are borrowed but no collateral or security is required.
What fees are charged?
The amount and number of fees depend on the type of credit account. All credit includes a finance charge in the form of an interest rate, which is basically the cost of borrowing money.
Credit Cards typically have the highest fees that can include an Annual Fee, a Balance Transfer fee, a Cash Advance fee and of course Interest. It is important to read all the paperwork the lender provides to be aware of the entire cost of using a Credit Card.
Home, Auto and Personal Loans also include an interest charge, both variable and fixed rates are available. Additional fees could include an application fee, an origination fee, late payment fees and prepayment fees.
There are many options available to todays’ borrower’s ranging from Banks and Credit Unions to online personal loan providers. The market is more competitive than ever, but ultimately it costs money to borrow money.
It is important to shop around to find the best rates and terms available. A lower interest rate could save thousands of dollars over the life of a loan.
Read on to learn more about improving your credit score.