By Elizabeth Nelson, Communications & Multimedia Content Producer
Financial intuitions like Greylock talk about credit a lot. Building credit. Improving credit. Credit scores. Credit cards. But what exactly is credit?
Simply defined, credit is an agreement between a borrower (you) and a lender (the financial institution issuing the credit card or loan) that allows the borrower to purchase goods or services now, understanding that you will pay for them later. Credit agreements typically include terms that dictate payment due dates, interest rates, and fees.
As you repay your debt, you build credit. In this definition, credit is an assessment of an individual's borrowing and repayment history. This assessment can be positive or negative, resulting in "good credit" or "bad credit."
In a way, credit tells a story about your spending and repayment habits. Positive habits like paying your credit card bills in full each month, paying more than the minimum payment due, and paying on time, tell a positive story and will help you build good credit. Your actions show that you can be trusted to borrow and repay what you borrow.
Challenging habits such as missing or making late payments or accumulating more debt than you can realistically pay off with your current income tell a negative story that can result in poor credit. These actions may make lenders wary of granting you a credit card or approving a loan, which can be problematic when you need to buy a house or car, or when you need to pay for an emergency such as unexpected medical bills. Credit is also impacted by other bills such as utilities, mortgages, and loans - paying in full, on time, and in accordance with your contracts is important to your credit story.
Credit is measured by a three-digit score between 300 and 850. The better your credit history is, the higher your credit score, which is used to help lenders make decisions about whether or not to lend to you. (Credit scores can sometimes influence hiring managers during job searches or landlords when applying to rent.) In addition to reflecting your borrowing and repayment habits and history, credit scores reflect longevity of credit usage - people who've had credit for a longer period of time have had more opportunity to accumulate credit.
If you're curious and want to learn more about credit scores, this short, informative article from Greylock's partner Banzai is a great place to start. In addition, this handout from the Community Empowerment Center explains the makeup of your credit score, how it's used, how to check your credit reports, and more.
The concept of credit, how it's built, used, and scored is complex, but there are some simple guidelines that can help keep you and your credit on the right track.
- Avoid paying interest by always paying off credit card bills in full. Treat your credit card like cash and only buy what you can pay off.
- Whenever possible, pay more than the minimum required payment in order to pay down debt as quickly as you can; this reduces the amount of interest you will have to pay.
- Ideally your debt-to-income ratio stays below 28%. To determine, divide the sum of your monthly debt payments by your gross monthly income.
- Try to never borrow too much at once, keeping your debt under 30% of what you're approved for. For example, if you're approved for $10,000, don't borrow more than $3,000.
- Do your best to pay at least 20% down when purchasing large items like a house or car. Then you won't need to borrow as much, which can save you money in the long run.
This article from Banzai covers these tips and includes a debt pay off calculator, explanations for types of credit, and other terms that may be helpful to understand. And remember, Greylock is here for you! Make time to peruse our Banzai library for self-guided learning, or schedule a time to meet with a Financial Wellness Coach. They can help you understand, grow, and improve your credit!