Why Credit Matters

Almost everybody needs credit. Sometimes, you don’t have money readily available to buy something you really need, or to cover unexpected expenses. This is where credit comes in. At Personify, we understand getting and managing credit isn't always easy. With so many different ways to borrow, making the best choice might not always be clear. With credit, you can borrow the money needed, with the promise that you’ll pay it back per the agreement created with the lender who makes that money available. However, to keep credit available for when you need it in the future, it's important to properly manage your debts. After all, managing credit and complying with the terms of your credit agreements can have a big impact on the terms of the credit that is available to you moving forward.

How Are Americans Managing Credit?

According to a Planning & Progress Study the average person has $38,000 in personal debt, excluding home mortgages. Credit card debt alone averages $5,554 per borrower and carrying a balance on a credit card month to month can be a substantial expense.

With so much at stake, having a good handle on where your credit stands should be a primary concern. The difference between a fair credit score (defined as 580-669) and a very good credit score (defined as 740-799) can equate to more than $45,000 over a lifetime of borrowing across the various debt types: credit cards, personal loans, auto loans, student loans, and mortgages. All credit is not created equal, and understanding the differences is crucial to your financial future.

What Are the Main Types of Credit?

There are three main types of credit:

  • Revolving – This is the type of credit most people envision when you start defining credit. Most credit cards are structured on a revolving credit basis. In a revolving credit arrangement, a borrower gets a credit limit and then charges expenses up to a set limit. The borrower then pays at least the minimum payment on that credit line each month and revolves the debt, unless they pay it off entirely by paying the balance in full.
  • Installment – In installment credit arrangements, a borrower borrows a set amount of money, with the agreement that they will pay the money back with interest through a set of payments for a set amount of time. Mortgages and auto loans are two common types of installment credit.
  • Open – Often overlooked in defining the different types of credit arrangements, most borrowers use service credit when they receive services from utility providers with the agreement that they will pay for their usage each month.

The 5 Cs of Credit

According to Bankrate.com, the top 10 reasons individuals take out personal loans are:

Character is what it sounds like. When potential borrowers approach lenders for money, the lender assesses the borrower’s character. What does that mean? The lender wants to know whether the borrower is trustworthy and credible. The lender also wants to understand your personality. Lenders assess your character through learning where you’ve been and what you’ve done (your credit history and work history) as well as by contacting references and evaluating your interactions with the lender.

Capacity is whether you can pay the loan back. Obviously, for lenders, capacity is critical. Even if your character is stellar and just about everyone thinks that you're a great person, if you can’t pay the loan back, it’s going to be a no-go. Here, the lender wants to know that you have the resources to pay the loan back. Lenders consider both your repayment history on other debt you’ve held as well as your financial metrics today, reflecting current debt, assets, and income.

Lenders like to see that you’ve put some of your own resources, i.e., capital, toward the investment for which you’re seeking additional funding. In terms of a home purchase, this C equates to a down payment. If you’re asking for a mortgage, a higher down payment will often lead to a more successful loan application, all other things being equal.

The conditions of a loan are just that, the conditions under which the loan agreement is made. Lenders consider individual-specific factors such as the size of loans, their interest rates, and repayment terms. Lenders also consider the conditions of the economy. These conditions could include the current unemployment rate, GDP growth, or impending legislation.

Like capital, this C also reduces credit risk in a potential lender’s eyes. Collateral is the assets you offer the lender to secure or guarantee a loan and offers lenders some recourse if you happen to default. These assets can include vehicles, properties, and even your primary home.

How to Get Credit

Keep the 5Cs in mind as you navigate the credit application process and work toward presenting yourself in the best possible light:

Character – Consider how you look on paper to a lender. What does your credit history look like? How does your work history appear? While there’s not a lot you can do to change what you’ve done in the past, you can manage the past you create going forward, and how you interact with the lender and represent yourself as an applicant.

Capacity – To show you have capacity, make room for new debt. You can do this by paying down existing debt. You can also examine your personal cash flow so that you know how much of a loan payment you can take on, given your existing budget and resources.

Capital – A higher contribution on your end will help convince lenders that you’re serious about your investment, and, likely, less of a default risk.

Conditions – There’s little you can do to control macroeconomic factors such as unemployment and GDP growth, but you can try to apply for credit when the economy is at or near its strongest and lenders are close to peak confidence.

Collateral – Be willing to work with the lender in identifying and offering up assets as collateral for your loan, if applicable.

Where to Find Your Credit Score and What It Means

You are entitled to receive this information for free at www.annualcreditreport.com. Federal law allows you to obtain a free copy of your credit report each year from each of the credit reporting companies. There are also many other ways to get your credit score. You may already be able to see your credit score on some statements provided by credit card companies or loan companies. Additionally, you can purchase this information from credit reporting services as well as other credit score services.

According to Experian, most Americans have a credit score between 600 and 750. While credit scores can go as low as 300 and as high as 850, lenders generally consider your credit to be ‘good’ once your credit score surpasses 700 and to be ‘excellent’ once it is over 800. Even though scores under 580 are considered to indicate bad credit, even those with a lower credit score are often able to qualify for a personal loan, depending on their circumstances. While people with low credit scores will likely pay a higher interest rate, there is help for those who fall into this category.

Without credit, we would often find ourselves unable to fund the purchase of larger assets, like homes and automobiles, and larger expenses, like weddings, medical bills, or expensive car repairs. Credit—whether it’s through charge cards, revolving credit, a loan, or service credit—allows us to make those purchases, pay for large expenses, and gives lenders confidence that they will get their money back. To help ensure that you will be able to obtain credit when you need it, it’s important to comply with the terms that you agree to with your lenders and to understand how they view your application for credit.

At Personify, our goal is to help you get the credit you deserve with an installment loan tailored to your unique financial situation. While your credit history is important, in many cases, we can look beyond just a credit score and approve people others won’t. And, Personify reports loan payment history to credit bureaus, so making on-time loan payments could even help your credit score in the long run.