How is your “Adult GPA”?
Some people call it the Adult GPA. We see ads for services that will check it and we hear companies tell you they will sell you product no matter what your credit is. We hear credit all the time, but how many of us truly understand what credit is? I promise if you sit through this article (I try to make it quick) you will probably know more about credit than you probably wanted to and trust me that advantage will serve you well as you navigate your financial future. Three main points I am going to tackle in this article are what is it, where you would use it, and why you need credit.
What is Credit?
This is money, a product or a service that is given to you with the expectation that you will pay it back in the future. The most common place people think of credit is with credit cards. You buy something on the card, but you are not responsible for paying that amount back until the end of the month.
So I bet your next question is
“How does a company know I am going to pay them back?”
This is where Credit Scores come into play. Most creditors will rely on the amount of credit they extend to an individual based on their credit score. Credit scores are a number that lenders use to make credit decisions along with other factors. One of the most common scores that creditors look at when determining your eligibility for credit is your FICO Score. FICO is a company that specializes in predictive analysis and their Score has become widely used among lenders.
What effects my FICO Score ?
Payment History — are you paying your bills on time (35% of FICO Score)
Credit Utilization — This is the ratio of how much credit you have versus how much you’ve used. Example: Your credit limit for your credit card is $5,000 and you have spent $3,000 on the card this month. You would have a high credit utilization which could negatively effect your credit score (30% of FICO Score)
Credit Mix — This is the different types of credit you currently have credit cards, student loans, mortgage, etc. (10% of FICO Score)
Hard Inquiries — This occurs every time a lender requests your credit report as part of the decision making process. They remain on your account for two years and can negatively effect your score.
Common hard inquiries
- Mortgage applications
- Auto loan applications
- Credit card applications
- Student loan applications
- Personal loan applications
- Apartment rental applications
Common soft inquiries
- Checking your credit scores on Credit Checking Services
- “Pre-qualified” credit card offers
- “Pre-qualified” insurance quotes
- Employment verification (i.e. background check)
Length of Credit History — This means how long any given account has been open. Generally the longer an account has been opened the more positively it will affect your credit.
The different types of credit
So the three main types of credit that most people will be exposed to are revolving credit, service credit and installment credit.
Revolving Credit — With revolving credit you are given a monthly limit on what you can spend and you must make minimum payments each month. If you make only partial payments the remaining balance will rollover into the next month’s balance. This is probably the credit people are most familiar with because this is how most credit cards operate.
Service Credit — Contracts you hold with utility companies, internet providers, gym memberships, etc are a form of service credit. These companies give you service and you pay them after the fact.
Installment Credit — This type of credit is a loan for a specific amount of money that you agree to pay back, usually with interest, over a specified time with equal monthly payments. Examples of this would be mortgages, auto loans, and student loans.
Why do you need credit?
Having good credit is important and necessary in a lot of your largest financial decisions. If you ever plan to buy a home or take out a loan to pay for your next car purchase having good credit can be a big help in these situations. The higher your credit score the lower your interest rate will be with mortgages, auto loans, and credit cards.
Other areas your credit affects you
Rental Housing — a landlord can check your credit when deciding if they will let you rent one of their properties. They will also consider your credit score when deciding on your damage deposit.
Prospective Employers — sometimes they will check this before making a hiring decisions.
Insurance Companies — these companies will use credit when determining rates for their clients
The reason these people will use credit when assessing you as a customer or employee is because credit is used as gauge of your responsibility as an adult.
Hopefully that read didn’t put you to sleep and was informative enough to make it worth your time. You now know what credit is, where it is used and why you need it. Love it or hate it but credit is the backbone of the US economy and the better you understand it the better you will be able to navigate it.
