Chances are you’ve heard the terms “credit score,” “good credit,” and “bad credit” thrown around here and there. But, while they all may be very familiar phrases, they can also be very confusing ones. After all, you don’t actually encounter your credit score on a daily basis, and your “good” or “bad” credit isn’t presented to you on a graded paper like a math test. They exist somewhere in the virtual world and may not come into play in your daily life. But credit — the root of it all — is actually a pretty important thing, particularly as you make increasingly more independent purchases in your life. It’s a good idea to get a handle on what it is and how it affects you (now and in the future), which is we sought out some expert help to break it down.
What is credit and what is it used for?
Credit is essentially borrowed money that you can use to buy everything from groceries, to a car, to a new home, and the agreement that you’ll pay the lender back at a later date, usually with an added fee. In short, it’s “how you make purchases in life when you don’t have the cash to buy something outright,” Shannah Compton Game, a certified financial planner (CFP) and host of the podcast Millennial Money tells Teen Vogue. “You’re leveraging someone else’s money, i.e. the bank or credit card company, to make purchases.”
And you’ll need to build a credit history, or a track record of borrowing and paying back credit, to make increasingly larger purchases. “It’s so important to build credit [history] because credit will help you buy stuff in life — whether you want to buy a car, rent an apartment, buy a house, or score that cool rewards credit card, you’re going to need credit [history] to do so.
How do you build credit?
Here’s where it gets a bit confusing. If you need a credit history to get a loan, but you can’t establish a credit history without already having some loans, how does it work? While yes, you’ll likely need a credit score to get a car loan or certain credit cards, there are ways to build credit from scratch. According to Student Loan Hero, there are certain types of student loans you can get (like federal student loans) without having a credit history, and paying back those loans helps you build credit history. That said, if you wouldn’t have taken out a student loan otherwise, it’s not the best idea to do so just for the express purpose of building credit. There are other ways to do so.
You can also start out with a secured credit card, which requires you to put down an initial cash deposit (usually at least $200, according to NerdWallet) to open the card. But unlike debit cards, secured credit cards aren’t funded by that deposit. You’ll still be borrowing money from the bank (your credit limit will likely be anywhere from 50 to 100% of the deposit), and you’ll still have to pay the monthly bills with money separate from the deposit, but the deposit serves as sort of an insurance policy for the bank. As myFICO explains, if you don’t pay your balance for a long time (becoming “delinquent”) or close the card without paying, the bank can use the money you already paid up-front to cover your debt. If you’re payed in full when you close the card or upgrade to an unsecured credit card with the same bank, however, you’ll get that deposit back. Essentially, aside from the initial deposit, a secured card “works just like any other credit card reporting regularly to the credit bureaus.” Game says. You can get a secured credit card from most major banks; just make sure you understand the required minimum deposit and any additional fees before you open one.