What Is Credit and How Does It Work?
On February 25, 2026 By newsroom Topic: Buying A House
Key Insights
- Credit Importance:
- Essential for major purchases like homes and cars.
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Affects financial opportunities such as renting apartments or securing loans.
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Creditworthiness:
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Evaluates how well you manage debts and pay bills on time.
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Negative Impacts:
- Late payments can significantly lower your credit score and harm creditworthiness.
How Credit Works
- Definition: A legal agreement allowing borrowing with a promise to repay with interest.
- Creditworthiness Factors (Five C's):
- Credit History: Track record of paying bills on time.
- Capacity: Debt-to-income ratio analysis.
- Collateral: Assets backing secured loans.
- Capital: Down payments or upfront payments.
- Conditions: Loan terms like interest rates and repayment periods.
Credit Report vs. Credit Score
- Credit Report: Detailed credit history and current accounts from Experian, TransUnion, and Equifax.
- Credit Score: A three-digit number (300 - 850) based on creditworthiness.
- Models: FICO and VantageScore.
Types of Credit
- Revolving Credit:
- Example: Credit cards.
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Access to a maximum limit with monthly payments and interest if not paid in full.
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Installment Credit:
- Example: Mortgages, car loans.
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Fixed payments over a set term.
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Open Credit:
- Example: Utility accounts.
- Balance must be paid in full monthly.
Factors Affecting Credit
- Payment History: Late or missed payments stay on reports for 7 years.
- Credit Utilization: Keep usage below 30% of your credit limit.
- Length of Credit History: Older accounts positively impact credit scores.
- Credit Mix: A variety of credit types shows responsible management.
- New Credit Applications: Too many inquiries can lower your score.
Maintaining and Improving Credit
- Pay bills on time.
- Use credit responsibly by keeping balances low.
- Monitor credit reports for errors.
- Consider reporting rent payments to credit bureaus to improve your score.
FAQs
- Does checking your credit score lower it?
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No, self-checks are considered soft inquiries and don't affect your score.
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Does applying for new credit affect your score?
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Yes, but effects are minor and temporary.
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Does bankruptcy hurt your credit?
- Yes, stays on your report for 7 - 10 years.
Bottom Line
Credit is an integral part of modern finances, affecting major life decisions like buying a home or securing a job. Building good credit takes time and disciplined financial habits, but the benefits are worth it for long-term financial health.
