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Chapter 1: What is Credit?

Introduction to Credit

Credit is your proven ability or inability to make payments over time. Your Credit Score is a formula that banks use to predict the likelihood that you will miss a payment in the next year or over the term of the loan.

Why Build Credit?

The only reason in my opinion to build credit is to use credit to make money. Most people build credit to borrow money to spend. If you are borrowing to buy a depreciating asset like a car or boat or vacation you are probably going to dig yourself a Credit Hole.

Another Definition of Credit


Credit is the trust that allows one party to provide resources to another party where that second party does not reimburse the first party immediately, but instead arranges either to repay or return those resources (or other materials of equal value) at a later date. Credit is extended by a creditor, also known as a lender, to a debtor, also known as a borrower. Credit does not have to be in the form of money; it can also be in the form of goods or services.


Do you have a Credit Report or Score?


If you are over Eighteen years old and have ever applied for a loan or credit card you will have a Credit History. Your Credit History will be converted into a Credit Score depending on what is in your history.  If you have applied for something where you had to give them your Social Security number then you probably have a credit report.


Credit Report vs Credit Score


A credit report is a detailed record of your credit history. It includes information about your borrowing and repayment activity, as well as personal information like your name, address, and usually a few past addresses. Credit reports are compiled by credit bureaus, which collect information from lenders and other financial institutions about your credit activity. There are three Federally approved Credit Bureaus.


A credit score, on the other hand, is a numerical representation of your creditworthiness, based on the information contained in your credit report. Credit scores are used by lenders and other financial institutions to determine your risk as a borrower and whether or not to extend you credit, as well as the terms of that credit.

What is a Credit Scoring Model?


There are many different credit scoring models, but the most commonly used one is the FICO score, which ranges from 300 to 850. The higher your credit score, the more likely you are to be approved for credit, and the more favorable the terms of that credit will be.


Another commonly used Credit Score is the Vantage 3.0. This is used by Credit Karma and others. It will approximate your FICO score.


Why is your Credit Score Important?


Many transactions in your life are impacted by your credit score.  Many people think that only their ability to buy a house or car is dependent on their score. 


However your car insurance, apartment insurance and even your ability to rent an apartment in many states can be affected by your credit score.  


And certainly your ability to get a low interest rate on your car or home purchase depends on your credit score.


Landlords can check your credit score and virtually all property management companies will check your credit score before renting you an apartment.


My First Credit Experience

I knew nothing about credit history. I knew nothing about credit scores. I had opened up a small bicycle shop. I was doing pretty well I had two credit cards and a discover card.  


We decided to buy a house. I had saved up a good down payment and we found a house we wanted to buy.   We made a large down payment and bought the house with owner financing. The lady that owned the house carried the loan. She never checked my credit.


Next I wanted to buy a larger house and rent out the house we were living in. I went to the bank.

They did not tell me what my credit score was, however I had to write a reason why I had been late on two credit card payments.

My wife and I had been 30 days late on two different credit card payments. I had no idea how important that is.

I got the home loan anyway because I had a big down payment.  Having a couple of late payments could have kept me from getting my first FHA home loan.


I set out to learn about Credit.  This was the beginning of my education on credit scores, credit history, and how credit works. Eventually as my career went on I earned more with borrowed money than I did working.


I have gone on to borrow money to buy several rental properties and owned a couple of businesses. Usually my credit score is bouncing around 800.


In my opinion the reason to build good credit is to use your good credit to make money.
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