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The Definition of Credit and Why You Need It

Last Updated: May 7, 2024
4 min read
Getting a credit card

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Key points about: What is credit?

  1. Credit is a system that allows you to borrow money to make purchases on the condition that you pay it back.

  2. Lenders determine whether to give you credit based on your credit score and the information in your credit report.

  3. You can take steps to improve your credit with responsible credit habits, like paying your bills on-time and keeping your credit usage low.

When you open a credit card account or take out a personal loan, you use credit. Credit allows you to borrow money from a lender for purchases on the condition that you’ll pay back the money later. Credit is one way that you can increase your spending power beyond the cash you have on hand or in the bank. Read on to learn what makes credit important and how to start building credit history responsibly.

Credit definition

Credit is an important tool in one’s financial toolbox. But it’s important to understand exactly what credit means so you can use it responsibly.

“Credit” is an agreement or system that allows one party to receive something valuable now, including access to funds, and provide payment later. “Credit” commonly refers to loans and credit cards. 

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Types of credit

Two common forms of credit are revolving credit and installment credit. 

Revolving credit: As the name implies, revolving credit is an ongoing type of credit. In other words, it’s a line of credit that you can borrow against as often as you’d like if you pay at least the minimum amount due on your bill and remain within your credit limit. Credit cards are a common form of revolving credit.  

Installment credit: Installment credit, on the other hand, is a fixed sum of money a lender gives you with a fixed repayment term. These are also sometimes called installment loans and can include things like student loans and personal loans.

How does credit work?

Your ability to manage different forms of credit responsibly may impact your creditworthiness. Lenders want to determine your creditworthiness before extending you credit, so they look at your credit report and credit score.

Credit report:

A credit report is a document that contains information about your credit history—your borrowing activity past and present like your loan-paying history and the status of your credit accounts. As you use your card and other forms of credit, lenders report your activity to credit bureaus. Each bureau organizes that information into a credit report. You probably have more than one credit report because there are multiple credit reporting agencies. The three major agencies are Equifax®, Experian®, and TransUnion®.

Credit score:

According to the Consumer Financial Protection Bureau, your credit score is a three-digit number that helps lenders predict your future credit behavior using the information in your credit report. Your credit score uses your past activity and habits as a borrower to determine your credit risk, or how likely you are to pay your debt on time.

Why is good credit important?

A high credit score or good credit score may show lenders that you practice good financial habits, like paying your bills on time and keeping your credit utilization low. While a low or poor credit score may signal more credit risk. 

 

Ultimately, whether you’re approved for credit can depend on multiple factors, and how lenders judge your credit score may vary. But there are some steps you can take to help improve your credit score.

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Why do you need credit?

Your credit history plays a key role in your overall financial well-being. A good credit history shows lenders and others that you’re responsible and trustworthy, making it easier to open a new credit account. You might need credit in order to access the following:

Credit cards

When you apply for a new credit card, the credit card company typically performs a hard credit check. Good credit may give you more card options on better terms, like a higher credit limit and a lower annual percentage rate (APR). Some cards don’t always require a credit score. 

Did you know?

You can build your credit with responsible use1 of the Discover it® Secured Credit Card. There’s no credit score required to apply.2 Instead, you provide a refundable security deposit, which will equal your credit line, of at least $200.3

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Mortgages and auto loans

You may also need credit when you try to buy a home or car. Having good credit may help you qualify for a loan at a lower interest rate. Interest rates are important, because the higher your rate, the more you may end up paying over the life of the loan.

Rental housing

When you apply to rent an apartment or house, the landlord may check your credit history. Even if you don’t have good credit, you may still qualify to rent. According to Consumer.gov, you may have to “pay more rent in advance if your credit history isn’t good.” 

Utilities and cell phone contracts

Your credit may also be a factor when you set up utilities or get a new cell phone contract. You can check local state laws to see if there are rules that utility or cell phone companies must follow if they want to review your credit score. You may be required to put down a security deposit if you do not meet the providers credit requirements. 

How can I improve my credit?

Even if you don’t have the best credit or believe you have “bad credit” you may still be able to build your credit history with good credit habits:

Your payment history is an important part of your credit score. You should aim to pay your bills on time, every time. A missed payment can impact your credit score and a history of late payments may show credit providers you have trouble paying back your debts. 

The amount of credit that you’re using versus the amount of credit that you have available is called your credit utilization. Your credit utilization typically makes up 30% of your credit score.

It’s important to regularly check your credit report for any errors or activity you don’t recognize, because these may be a sign of identity theft. If you see an error on your credit report, you can dispute it with the credit bureaus or the creditor directly. If the credit reporting agency or the creditor confirms that an error happened, they should take steps to remove the error from your credit report.

Where can I find my credit report?

According to the Federal Trade Commission, you can check your credit report from each credit bureau for free every week at annualcreditreport.com.

 

Credit can help you get the funds you need to invest in your future, whether it’s purchasing a new home, buying a new car, or starting a new business. It’s essential to understand the importance of maintaining good credit and managing debts responsibly.

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*There is no hard inquiry to your credit report to check if you’re pre-approved. If you’re pre-approved, and you move forward with submitting an application for the credit card, it will result in a hard inquiry which may impact your credit score. Receiving a pre-approval offer does not guarantee approval. Applicants applying without a social security number are not eligible to receive pre-approval offers. Card applicants cannot be pre-approved for the NHL Discover Card.

  1. Build credit with responsible use(Secured): Discover reports your credit history to the three major credit bureaus so it can help build/rebuild your credit if used responsibly. Late payments, delinquencies or other derogatory activity with your credit card accounts and loans may adversely impact your ability to build/rebuild credit.

  2. No credit score required to apply: Based on 2023 Discover it® Secured Credit Card application data, applicants without a credit score may qualify. You must meet other applicable underwriting criteria. When we evaluate your creditworthiness, we consider all the information you provide on your application, your credit report, and other information. If you have a credit score, we may use that in our evaluation.

  3. Secured Card Deposit Range: If approved, you must make a minimum security deposit of $200 (or more, in increments of $100 up to $2,500), which will equal your requested credit limit. Discover will determine your maximum credit limit by your income and ability to pay.

  • Legal Disclaimer: This site is for educational purposes and is not a substitute for professional advice. The material on this site is not intended to provide legal, investment, or financial advice and does not indicate the availability of any Discover product or service. It does not guarantee that Discover offers or endorses a product or service. For specific advice about your unique circumstances, you may wish to consult a qualified professional.