What is credit and why it’s important
January 29, 2026 • 5 min read
Credit matters more than most people realize when applying for their first credit card or loan. Not only does it affect your loan rates, but it may also affect your insurance rates and possibly where you work.
Whether you’re just beginning your financial journey or are trying to rebuild your credit, understanding the basics of credit can help you make important decisions about the type and amount of credit you need.
What is credit?
As a term, “credit” has more than one meaning. It can refer to your credit score, which is sometimes called a credit rating. This numerical value indicates your creditworthiness, which is a common way of describing a lender’s estimation of how much risk they may be taking when you take out a loan or line of credit. Having good credit, or high creditworthiness, means your loan is low risk because you’ve proven to be someone who pays back borrowed money.
Credit can also be synonymous with “credit limit” and refer to the total amount of funds you can quickly access.
What's a credit score?
A credit score is a number used to indicate a borrower’s creditworthiness. The lowest score is 300 and the highest score is 850. The higher your credit score, the better your odds of being approved when applying for a loan.
Credit scores are often categorized in ranges:
800 and above = Excellent
740 – 799 = Very good
670 – 739 = Good
580 – 669 = Fair
300 – 579 = Poor
How are credit scores calculated?
There are two primary scoring models used to determine credit scores:
- VantageScore
- FICO (Fair Isaac Corp.)
VantageScore is a relative newcomer to the industry, since it has only been around since 2006. FICO is an older entity, originating in 1956, but it’s only been calculating credit scores since 1989.
Both models calculate your credit score using algorithms based on information from your credit report. While the math differs for each entity, the factors that affect your score are roughly the same. In order of importance, they are:
- Payment history (Making on-time payments)
- Amount owed/Credit utilization (Borrowing a small sum in contrast to available credit)
- Length of credit history (Having older accounts in good standing)
- Credit mix (Having different types of loans or lines of credit)
- New credit (Not having several new credit accounts opened in short period of time)
For many, early credit scores, aka credit ratings, are first established by How using a credit card affect your credit score. Then as you take on more loans, the other credit factors start having an effect, giving you more opportunities to raise your score.
Why are credit scores important?
As a numerical calculation of your creditworthiness, your credit score affects your ability to borrow money and get lower interest rates.
If your credit score is too low, you’ll likely be limited to less desirable credit opportunities. In this case, you should be on the lookout for high-risk or even predatory lenders who charge substantial fees and extremely high interest meant to trap borrowers into cycles of continuous debt where the lender profits.
On the other hand, a high credit score can help you with the following:
- Home purchase — Your credit score should be high enough to demonstrate the capacity to repay a large, borrowed sum. Your score will also affect your mortgage rate, which will determine the total cost of your home and mortgage.
- Home or apartment rental — Many landlords require a credit score as part of the application to evaluate their risk and the likelihood you’ll make your rental payments.
- Utility deposits — Your utility company may require a deposit if you have a low credit score. The deposit may be lowered or waived if you have a higher credit score.
- Auto loans — Good credit means you’re more likely to be able to purchase the vehicle you want and not the one the lender is willing to finance for you.
- Auto insurance rates — Auto insurance premiums may be affected by your credit score. Better scores may mean lower insurance rates.
- Car rentals — You need to have credit to have a credit card. And having a credit card makes renting a car a lot easier than it would be if you rented with cash.
- Personal loans — Qualifying for loans can be difficult, especially when there’s no collateral to guarantee repayment. A good credit score can make obtaining a personal loan easier.
- Employment — Some jobs require a good credit rating for security clearances to handle large sums of money or to manage people who handle valuable items.
- Mobile phone service plans — Many mobile phone plans require good credit for a long-term plan.
- Emergencies — Your good credit can help you manage emergencies and unexpected expenses such as medical bills or home and vehicle repairs.
- Business loans — Businesses often start with personal credit. If you’ve always dreamed of being an entrepreneur, solid credit can help get your business off the ground.
How to check your credit score
There are several ways to get a free credit report with your credit score and detailed financial history, beginning with contacting each of the three credit bureaus.
You can also get all three reports from one source: AnnualCreditReport.com. If you prefer to check more often than once per year you may do so, for a fee.
Experian
888-397-3742
Transunion
800-916-8800
Equifax
888-378-4329
Key credit terms to know
Here are a few additional key terms, and some for review, that you should become familiar with:
- Credit: Money loaned to you from a financial institution, such as a bank or a credit card company. It may also refer to perceived creditworthiness and your credit score.
- Creditor: An entity that extends credit through a loan or line of credit. Also known as a lender.
- Credit report: A report that details credit accounts, payment histories and current balances of your past and present credit situation.
- Credit score: An assigned score based on your borrowing and repayment history that signals to creditors your capacity to manage your debt.
- Credit utilization: The amount of credit you’ve used compared to the amount of credit available to you.
- Debt-to-income (DTI) ratio: The amount of debt you owe each month compared to the amount of income you earn each month.
- Revolving credit: Credit accounts that are open-ended and don’t have specific start and end dates, such as credit cards. These accounts may also be called lines of credit, which is a more general category. Some lines of credit have closure dates.
- Installment credit: A credit account involving a specific amount of borrowed money to be repaid in periodic installments, like a loan, with a specific start and end date.
- Fair Credit Reporting Act (FCRA): An act passed by Congress requiring credit reporting agencies to verify the accuracy of the information they include in your credit report.
Understanding these basic terms can help you make wiser borrowing and repayment decisions as you work to build credit.
The bottom line
There’s no denying the importance of credit. It takes practice, diligence and self-control to manage your credit effectively. But the reward for doing so is a good credit score that allows you to purchase the things you need — and many of the things you want.