Credit means nothing.
Until we actually need it, most of us can continue to hurl through space on this giant rock, never having to ask ourselves these trying questions: What do I need good credit for? Who took my entire identity and crammed it into this arbitrary three-digit number? Do they hate me? Can I just ignore them forever? If a credit score falls in the forest and Credit Karma isn’t there to notify me about it, did it even happen?
For most of us, credit means nothing until we need to use it. That might mean trying to get a new apartment and figuring out that a high credit score lets you scoot to the front of the waiting list without a deposit. Or it might mean going to buy a car, and discovering that your poor score means a sky high interest rate for an awful run-down lemon, leaving you to pay a Tesla payment for the privilege of driving a run-down Datsun.
The truth is that credit seems pretty pointless until it helps us get what we want–or gets in the way.
So let's get some basics out on the table.
Table of Contents:
The Most Common Understanding of Credit
Credit is the ability to use money today and pay for it tomorrow. Good credit means you are good at taking out debt and sticking to the plan you have to repay it. Bad credit means that if someone lends you money, you might not always repay it the way you agreed to-- whether it's paid after its due date, or not repaid at all.
Your level of creditworthiness is expressed in a 3-digit number. It typically ranges from 350-850.
A low score means you are risky to lend money to.
A high score means you are safe to lend money to.
Credit in the 21st century is often used as yet another pathway to instant gratification–getting what you want now and paying for it later. This is why credit gets a bad rap (looking at you Dave Ramsey!). But the real value of credit has nothing to do with eating your money now. Rather, credit allows you to build through investing tomorrow’s money today.
You can get your credit scores from many different sources and you can get many different types of scores. The two most common scores are the FICO score and the Vantage score.
The FICO score is generated by Fair Isaac Corporation. FICO has created so many of the scores that are used to make decisions that it has become the ‘Kleenex’ of credit scores. You know, ‘Kleenex’ is really just the brand name for facial tissues but we don’t call them ‘facial tissues.’ That would be weird. FICO is the same thing–the industry standard credit score, but not the only one of it’s type.
FICO has many different models that try to predict if businesses should trust you with their money or services (and, more importantly, if they should charge you extra just to be safe). Your car loan FICO score, house loan FICO score, and insurance FICO score will all be different even though they are calculated using the exact same stuff- your credit reports.
The Vantage score is the next most common score. The Vantage score comes from the bureaus themselves (just wait until we unpack those bad boys). The vantage score is used for some lending decisions but mostly it's a great way to show people their own score for little or no money. My bet is that the credit bureaus got sick of doing all the work to air everyone’s dirty laundry and wanted to start making more of the cut- but nobody asked me.
You can often view your vantage scores for free from places that have sold you something or want to i.e., credit karma, which will send you offers for any credit card you might qualify for that will pay them money, your bank that you store your money at, or other credit products (heck even we are trying to get something out of you ((but it's way cooler)).
Vantage scores and FICO scores can be similar but sometimes they are way off. One of the most commonly asked questions on “CIG Credit Village”, a private Facebook group where people setting off on their own credit journey toward homeownership can connect and share tips, tricks, and setbacks, has to do with why the f there are ten million scores to view and which of them actually matter. The worst part is that there is no simple answer. Different scores are used for different things.
Remember how I said there are a ton of different scores but they are all calculated from the exact same stuff? Let's talk about that stuff. As soon as you turn 18 years old your credit reports start following you around. They hang on tight because they use your social security number. A credit report is a list of debts or agreements that you have and how you are servicing them. For example, you can see an auto loan lease and if you have been making your payments on time.
Each account on your credit report is called a tradeline. In addition to tradelines, you can find other information that might help keep track of you. Name variations might show your maiden name or your unfortunate highschool nickname that became a thing. There are even past addresses, some past employers, and people you’ve authorized to pull your credit reports.
While you can find a lot of information on your credit reports, there is even more information that the bureaus have tied to your social that you don’t see on credit reports.
Different combinations of this information can be put into the magic vantage or FICO facts and figures machine to spit out a score. The idea is that if you are trying to borrow a loan for a car the facts and figure machine should use more of the stuff that looks like car loans to put out its final score. If you think it sounds complicated then you aren’t dumb, you are just one of us huddled masses yearning to breathe free.
FICO and Vantage scores may not have been created with the sole purpose of making you feel like society has reduced your miraculous and unique human spark to a dead cold dollar sign but they certainly take the cake at making adulting the actual worst. While credit scores were initially created to empower the common person, they are inherently really freaking difficult. Here's why: the reason the FICO score is valuable is that no one has figured out how to reproduce it. That is the late Mr. Fair and Mr. Isaac's secret sauce. It's so difficult to unpack and reproduce that no one has ever been able to do it (and live to tell the tale). Part of its value is that it's complicated and intricate and smart.
The Three Bureaus
FICO did solve a giant problem when it came to lending decisions. The reports we have been referring to are put together by the three credit bureaus, TransUnion, Equifax, and Experian.
These companies started compiling records of how people pay back their debts. Some of them started out as just keeping ledgers at local stores where people bought stuff on layaway. Before the credit bureaus started keeping track records you only had your own family relationships to go off of. Think of the olden days when your Great Grandpappy had to have a good relationship with the local banker if you wanted to take out a line of credit.
Simply looking at that information listed on a report still left a lot of decision-making up to underwriters and bankers. This made it kind of difficult to know if you were in fact creditworthy or not. When you can turn all of that data into a score where higher means better and lower means worse, things actually do become a little more simple.
So it boils down to this: Your past borrowing activity is reported to the three bureaus who compile them into credit reports. Your credit reports are used to generate credit scores. Your credit scores quickly tell lenders if they should lend money to you and how much they should charge you to do it.
Yes, you could have just read that last paragraph but now you are a credit whiz.
This is essentially how credit affects our everyday lives but when it comes to borrowing money and using the infinite power of leverage to build wealth, it's only one piece of the puzzle.