What credit is and how lenders use it to decide about you
Credit is a lender's willingness to give you money now based on their belief that you will pay it back later. When you borrow money — whether through a credit card, personal loan, car loan, or mortgage — the lender is making a bet on your reliability. To decide whether to make that bet, they look at your credit history: a record of how you have borrowed and repaid money in the past.
Lenders do not decide based on a feeling or a conversation. They use a credit score, a three-digit number that summarizes your borrowing history into something they can compare across thousands of people. The higher your score, the more likely a lender thinks you will repay. A higher score also usually means you will pay a lower interest rate — the percentage of the loan amount that the lender charges you for borrowing.
If you have never borrowed money, you have no credit history and no score. Lenders see you as unknown rather than risky, but they may still refuse to lend to you because they have no track record to review. If you have borrowed money and missed payments, your score drops. If you have borrowed money and paid on time, your score rises.
Key Takeaways
- Your credit score is a number between 300 and 850 that lenders use to decide whether to lend you money and at what interest rate.
- Five factors make up your credit score: payment history (35%), amounts owed (30%), length of credit history (15%), credit mix (10%), and new credit inquiries (10%).
- You can build credit by getting a credit card or becoming an authorized user on someone else's account, making small purchases, and paying the full balance on time each month.
- Checking your own credit report does not hurt your score, but when a lender checks it to decide on a loan, that inquiry can lower your score slightly.
- If you cannot pay a bill, contacting the lender before you miss a payment is better than ignoring it — many will work with you on a payment plan.
The five things that make up your credit score
Payment history (35% of your score) is the single largest factor. This is whether you have paid your bills on time. A single late payment can lower your score, and the later the payment, the bigger the damage. A payment that is 30 days late hurts less than one that is 90 days late. Payments that are more than 120 days late can stay on your report for seven years.
Amounts owed (30% of your score) is how much of your available credit you are using. If you have a credit card with a $1,000 limit and you owe $900, you are using 90% of your available credit. This signals to lenders that you are stretched thin. Using less than 30% of your available credit is better for your score. This is why having multiple cards with low balances can help your score more than having one card with a high balance, even if the total amount owed is the same.
Length of credit history (15% of your score) is how long you have had credit accounts open. Older accounts help your score more than newer ones. This is why closing an old credit card can hurt your score — you lose the length of that account's history.
Credit mix (10% of your score) is having different types of credit: credit cards, car loans, personal loans, and mortgages. Lenders like to see that you can handle different kinds of borrowing. If you have only credit cards, your score will be lower than if you also have a car loan or mortgage, all else being equal.
New credit inquiries (10% of your score) is how many times you have recently asked for new credit. When you explore for a loan or credit card, the lender checks your credit report. This is called a hard inquiry and it lowers your score slightly. Multiple hard inquiries in a short time signal that you are desperate for credit, which worries lenders. Checking your own credit report is a soft inquiry and does not hurt your score.
How to build credit from scratch
If you have no credit history, the fastest way to build one is to get a credit card and use it regularly. You do not need to carry a balance — in fact, you should not. Charge a small amount each month (a gas purchase, a grocery bill, a phone bill) and pay the full balance when the bill arrives. This shows lenders that you can borrow and repay reliably.
If you cannot get a regular credit card because you have no history, a secured credit card is an alternative. You deposit money into a savings account — often $200 to $2,500 — and the card issuer gives you a credit card with a limit equal to your deposit. You use the card like a regular card, pay your bills on time, and after six to twelve months of on-time payments, the issuer may convert it to a regular card and return your deposit.
Another option is to become an authorized user on someone else's credit card account. If a family member or friend with good credit adds you to their account, their payment history and credit limits can show up on your report. You do not even need to use the card — just being on the account can help your score. This only works if the account holder has good payment history.
Building credit takes time. A new account will not show results for several months, and a solid credit history takes years. But starting early — even with small purchases — is better than waiting.
What your credit report contains and where to get it
Your credit report is a detailed record of your borrowing history. It lists every credit account you have opened, how much you owe on each one, whether you have paid on time, and any accounts that have gone to collections or resulted in judgments against you. The report also shows hard inquiries — times when a lender checked your credit.
Three companies — Equifax, Experian, and TransUnion — maintain most credit reports in the United States. They are called credit bureaus. Lenders report your payment activity to these bureaus, and the bureaus sell access to your report to other lenders, landlords, and employers.
You are may have access to to one free credit report from each bureau every 12 months. The official source is AnnualCreditReport.com, a government-authorized website. You can also request reports directly from each bureau's website. Do not use third-party websites that claim to offer "free" reports — many charge hidden fees or sign you up for monitoring services you did not want.
When you get your report, read it carefully. Look for accounts you do not recognize, payments marked as late that you believe you made on time, and old negative information that should have fallen off. If you find an error, you can dispute it with the bureau in writing. The bureau must investigate within 30 days.
How interest rates connect to your credit score
When you borrow money, you pay interest — a percentage of the loan amount charged by the lender. The interest rate you receive depends partly on your credit score. A person with a score of 750 might get a car loan at 4% interest, while a person with a score of 600 might get the same loan at 8% interest. Over the life of a five-year car loan, that difference adds thousands of dollars to what you repay.
This is why building credit matters even if you do not need to borrow right now. When you do need to borrow — for a car, a home, or an emergency — a higher score will save you money. A lower score means you pay more for everything you borrow.
Some lenders specialize in lending to people with lower scores, but they charge much higher interest rates to offset the risk. Payday loans and title loans, for example, often charge interest rates above 300% annually. Avoiding these lenders is one reason to build credit early: it keeps you from having to use expensive alternatives when an emergency happens.
What to do if you miss a payment or fall behind
If you cannot pay a bill on time, contact the lender before the payment is due. Many lenders will work with you on a payment plan, a temporary lower payment, or a deferment (a delay in when payments are due). These options exist because lenders would rather get paid late than not at all. Ignoring the bill and hoping it goes away is the worst choice — it guarantees a late payment will be reported and your score will drop.
If you miss a payment by 30 days, it will be reported to the credit bureaus and your score will drop. If you miss by 60 or 90 days, the damage is worse. If you miss by 120 days or more, the account may be sent to a collection agency — a company that specializes in collecting old debts. A collection account on your report will hurt your score for years.
If an account goes to collections, you still owe the debt. You can negotiate with the collection agency to pay a lump sum that is less than the full amount owed (called a settlement), or you can set up a payment plan. Getting the agency to agree to remove the account from your report in exchange for payment is rare, but it is worth asking.
Late payments stay on your credit report for seven years, but their impact on your score decreases over time. A late payment from five years ago hurts your score much less than a late payment from last month. This means that even if you have had problems in the past, building a record of on-time payments now will gradually improve your score.
Why lenders look at credit and what they are really checking
Lenders use credit scores because they are fast and standardized. A lender in California can compare a borrower in California to a borrower in New York using the same number. Without credit scores, lenders would have to interview every applicant and make a judgment call, which would be slow and inconsistent.
But a credit score is not a measure of how responsible you are as a person. It is a measure of how you have handled borrowed money in the past. Someone who has never borrowed money has no score, even if they are very responsible with their own money. Someone who has borrowed money and paid it back on time has a high score, even if they are irresponsible in other ways.
Lenders are checking one thing: will you repay this loan? Your credit history is the best predictor they have. If you have repaid loans before, you are likely to repay this one. If you have not, or if you have missed payments, they are less confident.
Frequently Asked Questions
Does checking my own credit score hurt it?
No. When you check your own credit report or score, it is a soft inquiry and does not affect your score. Only hard inquiries — when a lender checks your credit to decide on a loan — lower your score slightly. You can check your own credit as often as you want without penalty.
How long does it take to build a credit score?
You need at least one account with activity reported to the credit bureaus to have a score. This usually takes one to two months. But a meaningful score — one that lenders will trust — takes longer. Most lenders want to see at least six months of on-time payment history. A strong score usually takes one to two years of consistent on-time payments.
Can I remove negative information from my credit report?
Negative information that is accurate stays on your report for seven years (ten years for bankruptcy). You cannot remove it early, but you can dispute it if it is wrong. If the information is correct, your only option is to build new positive history. As time passes and you make on-time payments, the old negative information will hurt your score less.
What credit score do I need to get a loan?
It varies by lender and loan type. Most traditional lenders require a score of at least 620 for a car loan or 640 for a mortgage, but some require higher. Credit unions and community banks sometimes lend to people with lower scores. The lower your score, the fewer options you have and the higher the interest rate you will pay.
Is it better to have one credit card or multiple cards?
Multiple cards with low balances is better for your score than one card with a high balance, because it lowers your overall credit utilization. But only if you can manage them responsibly. If having multiple cards tempts you to overspend or miss payments, stick with one. One card used responsibly is better than multiple cards used poorly.