“Credit” has three definitions in the context of personal finance. It can refer to lending; a person or company’s financial reputation; or, in the accounting sense, funds received. We’ll explain each definition in more detail below.
3 Types of Credit
Credit allows consumers to borrow money in order to purchase goods or services now and pay later. In exchange for the money supplied on “credit,” or the borrowed funds, a lender can charge interest and fees. Collectively, these costs are referred to as “finance charges.” Finance charges limit the lender’s risk against a borrower’s potential inability to pay back what is owed.
This system manifests itself in a number of different credit instruments, which are described in the following table:
|Revolving Credit||An account with a maximum spending limit and a minimum monthly payment, allowing a balance to be carried, or “revolve,” from month to month||Most credit cards|
|Charge Card||An account with No Preset Spending Limit, whose bill must be paid in full each month because it does not offer a grace period||Many American Express rewards cards|
|Installment Credit||A loan for a specific amount, which typically must be repaid with interest in specified monthly allotments||Auto loans and mortgages|
(unrelated to retirement benefits)
|Services provided in advance of payment, thus requiring a credit check||Utilities and cell-phone service|
Credit can refer to a person or company’s standing, or reputation, within the lending industry. In this sense, credit is measured by the contents of reports maintained by the major credit bureaus. And that information is then used to calculate a credit score, a three-digit representation of all the financial decisions you’ve made in the past seven to 10 years or since you first established credit if it hasn’t been that long.
So if someone were to ask how good your credit is, for instance, he or she would likely be referring to the category it falls under: Excellent, Good, Fair/Limited or Bad. If you don’t know the answer, you can simply check your latest credit score for free on WalletHub.
Credit in the context of accounting refers to funds that you receive. A paycheck deposited to your bank account would be an example of a credit on your household’s balance sheet. The opposite of a credit is a “debit,” which refers to funds that you withdraw or pay with, such as a credit card payment.
Odds are this final definition for credit is a bit less familiar to many folks, considering that only 40% of U.S. adults “have a budget and keep close track of their spending,” according to the National Foundation for Credit Counseling. But you can learn more about the accounting definition of this term from our Guide to Credits vs. Debits.
For more information on all things credit, check out WalletHub’s Education Center or pose a question to our community of experts. You can also keep tabs on your credit by signing up for a free WalletHub account. You’ll get free daily credit scores and reports, personalized money-saving advice and 24/7 credit monitoring.