The word credit can mean a person’s financial standing, a balance or deposit when referring to a financial account, or the ability to borrow money with the promise to repay later.
Below is more information on the most used definitions of credit, along with the context surrounding each.
Credit When Referring to a Loan Agreement
Credit can refer to a loan agreement between a lender and borrower. The borrowed funds can be used to purchase goods or services on credit. Using credit means that you can borrow from elsewhere instead of paying out of your pocket upfront. Once you use those borrowed funds, you can pay back your lender in monthly installments.
Available credit is the amount of money borrowed from a lender that is available for use. You will most likely see this term with your credit cards, as they are a revolving credit line (you can borrow from them multiple times if you stay under your limit and make minimum payments).
When taking out credit, whether a loan or credit card, a borrower will have to repay the amount borrowed along with any interest charges.
And so, when referring to borrowed funds, credit can be synonymous with a loan or credit card.
Credit Score, Credit History, and Credit Worthiness
Credit can also mean an individual’s credit score, history, and creditworthiness.
Your credit score consists of variables such as your payment history, amount of debt, diversity of accounts, age of debt accounts, and account inquiries. A score can range between 850 (excellent) to 300 (very poor). It’s important to learn more about credit bureaus and how they calculate your score. These companies keep track of credit scores and reports from lenders and other financial institutions. It is essential to understand and check your credit score often!
Credit history will encompass your payment patterns, the kinds of debts you have paid off, are paying off, or are in collections or default. Any bankruptcies, co-signed loans, and joint loans will also be a part of your credit history.
Creditworthiness is what creditors and lenders look at when determining eligibility, loan amount, and interest rate for a borrower. Credit score and credit history, along with income, will help a lender determine creditworthiness. However, there are lenders that make loans available without a credit check.
A lender may ask for a hard credit check when determining credit eligibility, which counts as an account inquiry on your credit report. In comparison, soft credit checks do not appear on a credit report. Lenders use soft checks for pre-approval, and you can use them for a self-check on your credit score.
Credit Related to Overall Financial Health
Another place where you may hear about credit is when talking about your financial health. For example, when learning about debt-to-income ratio—the number of available credit accounts vs. your income. Or when learning to balance your credit utilization ratio—which measures credit usage with credit cards.
Financial Accounts and Credit
Credit can refer to any deposit to bank accounts, savings, and investment accounts. These deposits can be from a paycheck, a refund, rewards, interest, and returns from an Investment.
The word credit will come up in various aspects of finances. It can mean a borrowed loan or credit card. It can refer to your credit score, credit history, and creditworthiness. Credit comes up when discussing financial health and financial accounts. Familiarizing yourself with all these various roles that credit can take, depending on the context, is an essential part of financial literacy.