Takeaways
- Credit is the money you borrow with an agreement to pay back later.
- Credit payments are based on your annual percentage rate, term, and amount.
- Credit balances should be managed so you don't get into too much debt.
- Credit reports and scores dictate how lenders rank your ability to repay loans.
- Access to credit products allows you to finance buying a home or a new car and pay for everyday items with a credit card.
Credit is a powerful financial tool that allows consumers to borrow money with the promise of repaying it later—typically with interest. Whether you're applying for a credit card, paying for everyday expenses, buying a car, or securing a mortgage, credit plays a critical role in your ability to make large and small purchases and manage your personal finances.
Understanding how credit works, why it is crucial, and how to manage it properly can open doors to better credit products and financial opportunities and avoid costly pitfalls. Here is everything you need to know about credit and how to use it to your advantage.
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What Is Credit?
At its core, credit is the ability to borrow money or access goods or services with the agreement to pay later. Lenders, such as banks, credit unions, and credit card issuers, extend credit based on your income level, credit history, and perceived ability to repay.
An excellent credit score and high income give you financial flexibility, while poor credit can limit your options. Maintaining a vibrant credit profile means showing lenders that you pay your bills on time and in full when you borrow money.
Plug and Play: Debt-to-Income Calculator
How Credit Works
When you borrow money or use a line of credit, you enter into a contractual agreement to repay that amount, often with interest. Credit agreements vary widely depending on the lender, the type of credit, and your creditworthiness.
Factors like the Annual Percentage Rate (APR), repayment schedule, and loan term (length) will all be influenced by your credit report and profile. To understand your credit history, lenders will examine your FICO or VantageScore credit score. Profiles with high credit scores often get access to better credit products, like cash back credit cards or low-interest personal loans.
Responsible use of credit over time can help you build a favorable credit profile. Conversely, late payments or high outstanding balances can damage your credit standing. If you are considering applying for a mortgage or car loan, the APR a lender charges dramatically affects the cost of your purchase. Proactively managing your credit is a smart money move because your credit score and report influence access to credit products.
Read Also: What Is Your Credit Limit?
Credit Report
A credit report is a detailed summary of your credit history. Credit bureaus like Equifax, Experian, and TransUnion maintain it. Your credit report includes information like:
- The types of credit accounts you have (credit cards, personal loans, etc.)
- Your payment history (whether you have missed payments)
- Credit limits and balances (how much you are approved to borrow)
- Your average credit age (the length of time you have had accounts)
- Inquiries from lenders (happens when you apply for credit products)
Lenders use your credit report to assess your credit behavior and decide whether to approve you for a new line of credit.
Smart Tip:
You should review your credit report at least annually. Check for errors and accuracy. Start the 7 Steps to Get Your Free Credit Report today.
Credit Score
Your credit score is a three-digit number derived from your credit report. It reflects your creditworthiness and helps lenders evaluate your lending risk. Scores typically range from 300 to 850. Here is Smart Money’s guide to credit score ranges:
- 800-850 is considered excellent credit.
- 750-800 is considered very good credit.
- 700-750 is considered good credit.
- 600-700 is considered mediocre credit.
- 300-600 is considered poor credit.
According to Experience, 71% of Americans have a good or better credit score.[1] A higher score means you are more likely to be approved for loans and qualify for lower interest rates. If you have a lower credit score, you should improve your score before applying for a new credit product.
Read More: 5 Reasons You Have a Low Credit Score
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Improving Your Credit Profile
Improving your credit starts with building good financial habits. Here are some tips to boost your credit profile:
- Make On-Time Payments: Pay your bills on time—payment history is the biggest factor in your credit score. You can do this by managing your monthly cash flow with an effective budgeting system. Consider the 50/30/20 budget.
- Manage Credit Utilization: Credit utilization is the amount of credit you use relative to your approved credit limit. By keeping credit card balances low relative to your credit limit, you can better manage your overall debt.
- Time Credit Inquiries: There are two types of credit inquiries: soft and hard. Soft credit inquiries do not affect your credit score. However, hard credit inquiries can impact your credit score. To help reduce pings to your credit score, only apply for credit products when you need them.
- Review Your Credit Report: Regularly check your credit report for errors and dispute inaccuracies. You can contact the credit bureaus to file an objection if you see an error. Keeping your credit report free of mistakes is good credit hygiene.
- Consider Credit Age: Managing credit age can improve your credit score. Keeping older accounts open shows a long credit history and boosts credit scores. Just because you don't use a credit line often doesn't mean you should close it.
Read More: What Are the 5 C’s of Credit?
Why Consumers Use Credit
Paying with credit reduces the pain of the transaction and allows you to preserve cash. Swiping your credit card or paying with Apply Pay makes shopping super easy. You might want to buy now and pay later to manage your monthly cash flow. Here are reasons you might want to use credit:
- Cover unexpected expenses or emergencies.
- Make large purchases like appliances or vehicles.
- Manage cash flow and pay bills on time.
- Build a credit history for future loans.
Credit can provide financial stability, purchasing flexibility, and growth opportunities when used wisely. Buy now, pay later services have gone mainstream, too. It pays to keep your credit history pristine.
3 Main Types of Credit
Credit comes in several forms, each serving a different financial need. By understanding the differences, you choose the right type of credit for you. Here are the three main types of credit:
- Revolving Credit: Credit that renews as you pay off your outstanding balances (e.g., credit cards and personal line of credit).
- Installment Credit: Loans with fixed payments over a set period (e.g., personal loans, car loans, mortgages).
- Open-Ended Credit: Credit that can be used repeatedly until a set period and usually doesn't have a credit limit, but it has to be paid in full at the end of the billing period (e.g., charge cards).
Read More: What Is The 30% Rule?
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On Continental Finance’s Website
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5 Popular Credit Products
There are credit products to suit almost any financial situation. Here is a look at five popular credit products and how they work:
1. Credit Cards - Credit cards offer a revolving line of credit that you can use for purchases, bill payments, or even cash advances. They are convenient but sometimes have high interest rates if balances are not paid monthly. Many cards offer rewards, cash back, or travel points, making them appealing for everyday use. (Read the 7 Surprising Reasons You Should Use Your Credit Card).
2. Personal Loans - These are unsecured installment loans used for various purposes, from debt consolidation to home improvements. They typically have fixed interest rates and repayment terms, which makes them predictable and more straightforward to budget for. (Check out our personal loan step-by-step guide).
3. Personal Line of Credit - A personal line of credit functions like a credit card but usually has a lower interest rate. You can borrow up to a set credit limit and only pay interest on the amount you use. It is ideal for managing irregular expenses or having access to emergency funds.
4. Mortgage - A mortgage is a loan used to buy a home or real estate. The property secures it, and payments are made over long periods, often 15 to 30 years. Mortgage interest rates can vary based on your credit score, income, and down payment. (Read more about 30-year fixed-rate mortgages).
5. Payday Loan - Payday loans are short-term, high-interest loans typically used by consumers who urgently need cash. Due to their extremely high fees and short repayment periods, they can lead to a cycle of debt and are generally considered a last resort. (Read about How Payday Loans Work).
Smart Summary
Credit is an agreement to borrow money today with an agreement to repay it later with interest. It is an integral part of everyday life. Whether using a credit card, taking out a loan, or applying for a mortgage, understanding how credit works lets you make smart money moves. By managing credit responsibly, reviewing your credit report regularly, and improving your credit habits, you can build a strong financial foundation that gives you access to the best credit products.
Smart Money requires our expert writers to rely on trusted primary sources—academic research, government reports, expert interviews, original reporting, and peer-reviewed data—to deliver precise and up-to-date content. All of our content is thoroughly fact-checked. We also incorporate relevant research from reputable publishers when it aligns with our editorial focus. For a closer look at our rigorous journalistic standards, explore our editorial guidelines.
(1) Experian. What Is a Good Credit Score? Last Accessed April 5, 2025.
