Credit Management Related Definitions and Terms: Credit 101
There are so many ways one can explain credit management, but let’s stick with this: Credit management means making timely payments, managing debts, using credit wisely, and taking steps to put your credit in the most positive light possible. You could say it is cleaning up or keeping your credit cleaned up to make you favorable to potential lenders and others.
What Is Credit Management
It is about fixing past issues and attempting to prevent any future ones that could affect your ability to borrow money, get a job, or move. As I said, there are many ways to explain it, and you can do it yourself or pay a professional to help. If you are working on credit management, that means taking steps to improve your current credit situation.
To do so, there are many terms you need to know. If you try to do this without knowing common terms of credit management, you are going to find yourself drowning in a sea of confusion and- possibly- giving up before you even get started well. Let’s prevent that problem by going over common terms you will run across while putting a credit management plan into place.
Credit Report 101
Credit Report
Consider your credit report as your adult report card, and it is a huge part of credit management. It shows how well you have repaid your debt in the past, how much debt you have, your credit mix, and more. Lenders report either positive or negative credit behavior on your part, which is then available for future lenders, landlords, employers, and whoever else needs to see it.
Credit Score
If your credit report is like your report card, you can consider your credit score to be like your credit grade. Your grade is represented in a number that ranges between 300 and 850, which is your credit score number. Lenders use that grade to determine if you are trustworthy enough to repay a loan. You have probably heard of both a FICO score and a Vantage score, so we will discuss those next. These are the two main scoring systems, and the most commonly used credit scores explained:
FICO Score
FICO stands for “Fair Isaac Corporation”, and it is the most common of all scoring systems. It has been around since the 1980s and was created with the intention of showing lenders which borrowers will probably not repay their loans. FICO uses five categories of your credit to give you a score, like this:
- Payment history of your credit - 35%
- Amount of debt (Credit Usage/Utilization) - 30%
- Age of credit - 15%
- Type of credit you have (Credit Mix) - 10%
- Credit inquiries - 10%
Vantage Score
Vantage did not come into play until 2006, and it was created by the three major credit bureaus: TransUnion, Equifax, and Experian. The credit bureaus wanted a scoring system that translated a bit better across all of the credit reports and bureaus, but they did eventually adopt the same 300 to 850 credit score numbers to simplify credit management. The VantageScore 3.0 grade takes six categories into account as follows:
- Payment history of your credit - 40%
- Age and types of credit - 21%
- Total debt - 11%
- Available credit - 3%
- Percent of credit used - 20%
- Recent inquiries and credit behavior - 5%
Both scores use the same information to grade you, but they each place a different weight on those numbers, so the scores will be different. The next few terms will be breaking down these specific categories for a deeper understanding.
Credit Usage or Credit Utilization
Let’s go straight up elementary school here for a minute. Tell me if this sounds familiar: You have a cake that you slice into ten pieces. You eat three pieces. How much cake do you have left? You have 7/10 of that cake left, right?
Keep It under 30%
Credit utilization is pretty much like that. It is the amount of credit you have available to you compared to how much you are using. So if that cake was a loan from the lender, you still have 7/10 of the loan left available to you (70%), meaning you are utilizing 30%. Lenders do not want you to use the full amount of your available credit. They want to know you have credit that you can use but that you do not need to use. Seems silly, right? I mean, if you already have credit available, why do you need to look for more credit?
I will not pretend that everything about credit makes sense all of the time, but you can think about it like this: If you use everything you have, you look either irresponsible or like you are in pretty bad financial shape. Lenders do not want to loan money to irresponsible people, or people who have nothing left over.
Just remember that keeping your credit utilization under 30% makes you much more desirable. If you are using more than 30%, you have two ways to fix it, and using both ways simultaneously can help you even more. The first way is to pay off some debt. The second is to get more credit, but you want to mix up what type of credit you have, so let’s talk about the credit mix next.
Credit Mix
Ok, so let’s go back to the cake for a moment (sorry if I’m making you hungry). When you bake a cake, you need multiple ingredients. If you use nothing but flour, you will have nothing but flour. If you mix flour with milk, you will get some type of dough, but not the cake you are looking for. Baking a cake requires more than one or two ingredients. And, depending on the flavor of cake you are going for, some cakes need more ingredients than others.
Different Types of Credit
Your credit is the same way. If you have nothing but credit cards, your credit is a little bland. If you have nothing but student loans, well, the same thing. Lenders need to see that you have a mix of “ingredients”, or credit types, on your credit report. Remember the credit score systems- both of them- that we mentioned above. Credit mix carries a certain amount of weight, so you want to mix it up.
Two of the main credit types that hold a lot of weight are revolving credit and installment credit, but there are a total of four that we will go over in-depth in a moment. For now, let me make the point that if you at least have revolving credit and installment credit, you are doing pretty good. You can strive for all four credit types, but when I was speaking to a lender once, she emphasized just how important revolving and installment credit are. She did not even mention the other two, so while they can all help, make a big effort to go for revolving credit and installment credit.
1. Revolving Credit
We will break this down using a credit card, but do know that there are other types of revolving credit, including loans and lines of credit. The way they work is simple: You get approved for a set amount, you use your credit, you repay it, it is available again. It is like having a bottle of water. When you drink the water, as long as you refill it, it is available the next time you are thirsty.
With a credit card, you are given a credit limit- we will say $200 for now. That $200 is available to you until you spend it. Once you do, you must repay that balance with interest. As long as you do that, the $200 is there to spend again.
2. Installment Credit
With installment credit, the full amount you are approved for is given to you upfront. You then pay it back in installments, along with any interest and fees, over a set time period. For instance, say you go to a lender and borrow $1,000 at 5% interest for a year. This means you owe a total of $1,050, which will be spread out over 12 payments. Your payments are $87.50 per month.
As long as you make those payments on time every so there are no late fees added, you will have the installment loan paid back in full with that 12th payment. Installment credit comes in the form of car loans, mortgages, student loans, and personal installment loans.
3. Service Credit
This is really simple. It is the credit you have with places such as your utility companies and even gyms and your cell phone bill. It basically means that a company provides you a service and you pay for that service each month. Most often, this credit is not automatically reported to the credit bureaus. You can go through the process of getting them added, but you have to put in some work. However, if you mess up and go into default with them, they will not hesitate to report you.
4. Charge Cards
You know what I mean here. You walk into a store, and they try to give you a card for that store so you will spend more. The card is exclusively for that place of business, and they can be helpful in times when your kids need new shoes or your oven goes out and you do not have the cash to pay outright at that moment. You swipe them just like a credit card, but you have to have the balance paid off by the end of the month.
Stores have started changing these up a little, starting to let you carry a balance like a credit card, as long as you make minimum monthly payments, but it does not take long for them to get out of hand.
*An Important Note Here
While you do want a good credit mix, you do not need to get a bunch of credit you do not need. In other words, do not try to open $50,000 in credit cards just to help your credit because you will end up hurting yourself instead. Be strategic about the credit you get. It never hurts to have a credit card or an installment loan, but keep it simple. And if you get them, be responsible with them.
Payment History
This is probably a very self-explanatory credit management term, but that’s okay. There are a few things to mention here. Your payment history is obviously how well- or not well- you have repaid debts. This is a big deal in any credit scoring system and, for that matter, in any language, country, and so on. If you have a history of not paying your debt, or even not paying it on time, no one wants to loan you money.
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And, really, can you blame them? If your brother always asks for money that he never repays, or it takes him years to repay, do you want to loan him more? Probably not. If you give money to someone with the understanding that you are supposed to get it back, you expect to get it back. If you don’t, you do not want to make that same mistake again.
Very Important to Lenders
The same goes for lenders. They want to loan money because they make money when they do. They do not want to give it away. So they are going to take a look at your credit and see how well you have repaid debts in the past.
When they take a look, they are going to see notes from previous lenders who not only report whether you paid late or on time, but also how late you were. If you see numbers such as 30 days, 90 days, and so on around a certain debt, that is the lender letting your potential lenders know just how behind you got on payments.
Payment history is a big deal, and it is definitely something you need to pay attention to in with your credit management. You might not be able to change the past, but do be sure to do better this time around. If you build up a steady recent history of on-time payments, it will begin to cross out your late payments, so- in a way- with some work, you can kind of erase those bad marks.
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Credit Age
Credit age simply means how long of a general credit history you have. If you have just turned 18, your credit age is basically nonexistent since you are just starting out. It can also be affected, though, by just how long you keep credit lines open, such as how long you have had a credit card or actual line of credit. By keeping credit lines open longer- and in good standing- you can definitely improve your credit age.
Inquiries or Credit Check
When someone takes a peep at your credit, they are performing an inquiry- or a credit check. There are two types of inquiries: soft and hard credit inquiries.
1. Soft Inquiries
Soft inquiries do not really affect your credit. If you are applying for a job, your potential employer might perform a soft inquiry. If a credit card company is preapproving you, it will be a soft inquiry. Basically, soft inquiries occur when you are not applying for shopping credit. Due to the fact that you are not trying to get credit and the fact that you do not always know these inquiries are happening, you are not punished by these. They do not factor in your credit score.
2. Hard Inquiries
Hard inquiries are quite different. If you apply for a loan, credit card, or something similar, you will get hit with a hard inquiry. These do affect your credit scores. It’s almost like a soft inquiry is when a creditor is dipping their toes into the water while hard inquiries are like them doing a deep dive.
Here is something important to know about hard inquiries: Every time you apply for credit, the hard inquiry has the potential to affect your credit badly. However, if you are strategic about your applications, you can minimize the effect. What I mean by this is this: If you have decided to apply for a car loan, do all of your applications within a two week period. When you do this, all of the car loan hard inquiries will be rolled into one hard inquiry instead of 20.
This, though, does not only work when it is in the same industry, in this case, car loans. If you are looking for a mortgage at the same time, the mortgage applications will count as a second hard inquiry. Bottom line: be strategic about your applications and you can keep the negative impact to a minimum.
Credit Monitoring
Do you have security cameras around your home or are you at least familiar with security cameras? They keep an eye on the area they are faced with and make you aware of any potential issues- like thieves.
Credit Monitoring
A vital step in credit management- it is like having security cameras on your credit. You can find out about any potential issues or new items being reported. You can look for any charges that you did not make and the ability to dispute it before it settles in. There is more than one way to monitor your credit.
You Can Hire a Credit Monitoring Service
For a monthly fee, they will report any issues to you, often including any time they find your name in a data breach or other playground for identity thieves. These can get expensive, but they can also be worth it.
Do It Yourself
You can also do it yourself, and honestly, you should do it yourself even if you hire a company. No offense to credit monitoring services, but two eyes are better than one. And, anyway, if you sign up for an account through Credit Karma or somewhere similar, you will get an alert anyway when something new lands on your credit. I love Credit Karma as they keep me informed through emails, and even try to help me fix issues. Best of all, it’s free.
Do It Regularly
Regardless of what tools you use, you need to routinely monitor your credit. As credit can change quickly, the more often, the better. Set a date with yourself- I do it once a month at least- to log onto Credit Karma and take a look at what’s on my credit. Once a year, I get the full free reports from all three credit bureaus. You can do this, too, every time you are denied credit.
When the information is in front of me, I make sure that everything looks familiar. If it does not, I dig in to find out everything I can about that debt. If I still don’t recognize it, I dispute it. Sometimes, when I see one debt from two places, such as if I have a debt that was sold to a collections company, and it’s still reported by both companies, I quickly dispute it to get the original off as quickly as possible.
In addition to making sure everything is accurate, I use this time to see if my debt repayment plan is still on schedule and if I still have the best plan in place. As debts are the most harmful to your credit in the first two years of being reported, sometimes (unless you already have an agreement with one debt company) it is better to switch gears and pay off the new debt first.
All of these steps I mentioned are part of both credit monitoring and credit management. Looking at your credit, checking it, making sure of accuracy, making or changing plans, and so forth are all important steps.
Debt Management
Part of credit management is obviously managing your debts, so let’s talk about four important terms involved with that.
Debt Settlement
Debt settlement is when you agreed to pay a debt at a lower amount than the full amount due. This is common and simple. Sometimes you may get settlement offers in the mail from creditors, especially around tax time. If it is possible, take advantage of these.
You can also call the creditor yourself and ask for a settlement. They usually agree, especially if the majority of what you owe is fees and interest. Besides, they would rather have a portion of what you owe than nothing at all. You can work your way down your list of debts doing this- just don’t call them all at once. Then, they all want to get paid at once. Instead, following either the debt snowball or debt avalanche mentioned next, do one at a time.
It is also important to note that settling debts is going to help a lot more than it hurts. The difference in paying a debt in full and settling debt is only about two points on your credit. Getting it off of your credit is the most important thing.
Debt Snowball
The debt snowball is one systematic way to attack debts. You simply list your debts in order from smallest to largest according to your balance due. You then start at the top of the list, pay the smallest off first, then move to the next one until they are all gone.
What Is the Snowball Method?
Debt Avalanche
A debt avalanche is the opposite. You list your debts in order from the largest balance to smallest. Paying off the largest first will have a big quick impact on your credit immediately, but if you do not make a lot or have a lot of money coming in some other way, it may not be possible.
Debt Consolidation
Debt consolidation means getting rid of many debts at once in exchange for another. Add up your debts, go take out a personal installment loan for the balance, then pay off your debts. Now, you only owe the installment loan. If you do this, be sure to call for settlement offers before making any payments. You just might get to pay them off for a fraction of the amount you think you need.
Conclusion
Whether you are new to credit, behind on debts, or doing okay, credit management is an important- and ongoing step- in being financially stable. It is hard to do anything in life without credit. Even when you do not need credit, some people and organizations use it as a way to judge your character.
Regardless of your plans and dreams for your life, successful credit management can make the journey much smoother. Give yourself the best shot in life by managing your credit responsibly and being wise in your financial decisions.