What is credit?
Credit is when a person borrows a set amount of money paid back over time, usually including interest. Three types of credit are used to calculate your credit score. One type of credit doesn’t fit all situations, so we’re diving in to cover what type of credit to use for what financial event, along with how potential lenders rate your “creditworthiness.”
1. Revolving Credit
This type of credit is when a lender allows you to repeatedly borrow money up to a set limit while paying back over time. This line of credit continues to stay open as long as on-time minimum payments are made. This may include interest.
Examples of revolving credit:
– Credit card
– Home equity line of credit (HELOC)
– Personal line of credit
Example of how revolving credit works:
You apply for a credit card and are given a $1,000 limit. The first month, you charge $800 of purchases to the credit card. You now have $200 left of that $1,000 credit.
→ If you make a full payment of $800 on the due date, the line of credit increases back to the original $1,000 limit.
→ If you make a partial payment of $300 on the due date, the line of credit increases to a $700 limit for the next month. A partial payment might also include additional interest for carrying a balance into the following month.
2. Installment Credit
The second type of credit is when a lender allows you to borrow a specific amount of money with a set amount and payment schedule over an agreed amount of time. This line of credit has an end date and may include interest.
Examples of installment credit:
– Car financing
– Student loan
Example of how installment credit works:
You apply for a loan to buy a home. The lender loans you $250,000, and an agreement is signed that you will make a payment every month for the next 30 years along with interest (in most cases).
→ If you choose a fixed interest, you’ll pay the same interest rate until the loan ends. Example: 2.99% APR for 30 years.
→ If you choose a variable interest, you’ll pay an interest rate that increases or decreases over the course of the loan. Example: 1.99% – 3.99% APR for 30 years.
3. Open Credit
The final type of credit is a blend of installment and revolving credit. This is when a lender allows you to borrow a different amount every month, and payment is due in full every billing cycle. This line of credit usually does not include interest but may include late payment fees.
Example of installment credit:
– Water bill
– Electric bill
– Gas bill
Example of how open credit works:
You open an account with an electric company. The first month your household uses $135 worth of electricity, and a bill for the full amount is sent after the cycle closes. The following month, your household uses $75 worth of electricity, and at the end of the month, a new bill with a different amount is sent to be paid in full.
→ If you make a full payment on the due date, you can continue using electricity.
→ If you make a partial or no payment on the due date, the electric company may charge late fees. Multiple missed payments may result in the services being temporarily suspended until the amount owed is repaid.
How credit affects your credit score
Have you ever wondered why you have different credit score results? It’s because there are 3 major credit reporting agencies, TransUnion, Equifax, and Experian, and their reporting methods vary. For our credit score example, we’ll cover what affects it by using the FICO® Score model.
There are 5 categories in determining your credit score.
35% | Payment History
The largest chunk of your credit score is tied to the consistency of on-time payments. It’s important to keep up with monthly payments, even if you’re only able to pay the minimum amount owed. Missing a payment due date may affect your overall score.
30% | Amount Owed
The second-largest largest factor has less to do with the amount borrowed and more about how much of your available credit is borrowed. An example of CUR (credit utilization ratio): you have an available credit line of $10,000 but are only using $500 of it. The CUR is 20%. The size of that CUR percentage is what may impact your score. Most experts agree that it’s best to keep your CUR at 30% or less. The credit bureaus want to see that you aren’t using 100% of your available credit.
Pro Tip → Calculate your CUR by [ balance owed ] ÷ [ credit available ]
Example: $250 balance ÷ $3,500 available = 14% CUR
15% | Credit History Length
Another contributing factor is how long the line of credit has been open. Having a long history of unused credit available can help increase your score. It’s a common misconception that if you aren’t using the available credit, it’s best to close the account. Still, the closing may negatively impact your history score—credit availability without usage signals positive finances to the bureaus.
10% | Credit Mix
This percentage is tied to the 3 types of credit we mentioned at the beginning of the article: installation, revolving, and open. Having a variety of credit signals responsibility.
10% | New Credit
The last bit covers how much new credit you are asking for and how fast. It can be a key indicator that your finances aren’t doing so hot if your CUR is north of 30%. Experts recommend spacing major financial events, such as financing a car, opening a new credit card, or applying for a home loan. Too many new credit requests popping up on your report in a short timespan can lead to a credit score dip.
Coming Soon | One’s Credit Builder
One’s Credit Builder helps you live life while automatically building credit history. There’s no fees, no interest, and no paycheck direct deposit required to join! We’ve designed an easy way to build or rebuild your credit history that’s fully integrated into your One account. Let’s take a quick tour of One’s Credit Builder.
Join Credit Builder Beta by signing up here.
How One’s Credit Builder works
1. Add Pocket → Add to your One dashboard then fund the Credit Builder Pocket.
2. Spend → Assign your One card to the Credit Builder Pocket then spend as usual!
3. Build Credit → Every month, One will report the automatic on-time payment to the major credit bureaus.
How can One’s Credit Builder help improve my credit history?
The key to building good credit history is consistency. One’s Credit Builder can help by making automatic on-time payments to the major credit bureaus. Use the Credit Builder Pocket for everyday purchases like gas, groceries, or other bills, and we’ll report the full, on-time payments every month. This easy swap to spending from the Credit Builder Pocket can have big results towards building up the length of your positive credit history.
When and what does One report to the major bureaus?
Every month, we’ll automatically report to the major bureaus that your account has made a full, on-time payment. One doesn’t report your Credit Builder Pocket limit because the amount put in that Pocket is up to you! Also, how you use your Credit Builder Pocket is not reported. The “card utilization” is not reported because there isn’t a set credit limit. You won’t have to worry about going over that golden 30% CUR we covered earlier.
How does Credit Builder compare to other programs?