What Is Credit and How It Works

Every time that you make a purchase with the promise to pay for it later or take a loan to buy something now and pay in installments for it later you are using credit. The commonest kind of credit is using a credit card and applying for a loan to make a purchase. Whenever a creditor agrees to give you money on credit he does so on the basis of your creditworthiness which is a measure of your liability to pay back the money that you borrow. Creditors usually rely on the credit report present with the credit bureaus to determine the risk of a consumer before landing in the money. Other factors such as employment, job stability, income and residents may be taken into account by the creditor in order to determine the risk worthiness of an individual.

Using credit responsibly is the only way to build a good credit score and maintain a healthy credit file with the credit bureaus. New consumers who have not used credit in the past and do not have a sufficient credit history may face a little more difficulty in getting credit as the lender will have to rely on the other dimension factors such as employment, income and job stability. They may also ask for someone with reliable credit worthiness to cosign on your application as a guarantor.

How Credit Works?

In order to apply for a credit you need to make an application to the creditor. Creditor will then use the information present on your credit report and use identifying information such as your address and social security number to investigate your creditworthiness. If your credit report and your credit rating are sufficient to prove that you are a good risk the lender will approve you for the credit or the loan.

Every line of credit or a loan comes at certain terms and conditions. These terms and conditions will be presented you in a written format in a contract form. They usually cover how you supposed to repay the loan and the interest rate being charged as well as other actions that the creditor can take in different circumstances such as non-payment.

If it is a matter of getting a credit card, the lender will also established the maximum credit limit which is the maximum amount of money that you can use in a particular billing cycle.

If it is a secured debt such as an automobile loan or a mortgage form loan, you will know your monthly installments and payments right from the start. You will also know if the interest rate is fixed or it can vary according to the changing interest rate in the economy.

If the credit you are going to use is an unsecured line of credit such as the revolving credit on a credit card, your payment every month will depend upon the amount you charge.

It is important to understand that credit should not be used as a substitute for cash in the wallet. You should only use a credit card to charge put you can afford and preferably what you can afford to pay off in full at the end of the billing cycle when it’s time to make the payment to the credit card issuer.