The basics of consumer credit

Posted 6/14/23

METRO

A strong credit score is an undeniable asset for consumers. A strong standing in the eyes of potential creditors can save consumers money on relatively short-term expenses like vehicles …

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The basics of consumer credit

Posted

METRO

A strong credit score is an undeniable asset for consumers. A strong standing in the eyes of potential creditors can save consumers money on relatively short-term expenses like vehicles and long-term purchases like homes.

Consumer credit is so influential in the lives of the average person that it pays to have some knowledge of what it is and how individuals can use it to their advantage.

Who issues consumer credit?

Consumer credit is typically issued by banks and retailers. One common question consumers have is who owns credit cards, which are among the most recognizable and widely used forms of consumer credit. Many credit card companies, including Visa, are now publicly held companies after years of being owned by banks. However, many major banks, including Capital One and Bank of America, issue credit cards as well.

What is a credit score?

According to the credit reporting agency Equifax¨, a credit score is a three-digit number which represents an individual consumer’s credit risk. Credit risk refers to the likelihood that a borrower will pay their bills on time. Scores are typically between 300 and 850, and the higher the score, the more creditworthy and less risky a consumer is in the eyes of creditors.

How are credit scores calculated?

Three different consumer reporting agencies (CRAs), including Equifax¨, determine credit scores. That’s why it’s not uncommon for a single consumer to have three different scores. Those scores should be similar, and if they’re not it’s likely that one or more CRA reports has an error or errors. A host of variables are considered when determining a credit score, and these include:

•  Payment history

•  Credit utilization ratio, which is the amount of credit used versus the total available credit

•  Types of credit accounts a consumer has. This includes revolving credit accounts, like consumer credit cards, and installment accounts, which include mortgages and auto loans.

•  Credit history length

•  Frequency of credit inquiries (numerous inquiries in a short period of time generally lower a consumer’s credit score)

So why is a credit score so important?

Credit scores are so significant because they can cost or save consumers a substantial amount of money. Consumers with poor scores, which are generally considered scores between 300 and 669, may not be eligible for auto or mortgage loans and may only be able to secure credit cards with high interest rates. By contrast, consumers with scores considered very good to excellent (740 and above) generally get more favorable interest rates on sizable purchases like cars and homes, which can save borrowers tens of thousands of dollars over their lifetimes.

Managing credit is a vital component of financial planning. Knowing the basics to consumer credit can set individuals on a sound financial path. 

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