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What is credit and why is it so scary?

May 11, 2020 | Brian Powers
Making Cents of Finance Part 6

Admittedly, the idea of credit is slightly scary. One thing I have learned about credit as I’ve gotten older is that I actually know very little about it. Sure, I was told about credit by my parents and teachers as I was growing up, but I, like many, was never educated on credit. In the next few installments of Making Cents of Finance, I will go over the ins and outs of credit, what it is, how it works, and other ways to stop viewing credit as a cyclops-type of monster and to learn how to dismantle its scary exterior until it’s a cuddly teddy bear of knowledge.

So exactly what is credit anyway?

The answer to this is complex, but the official, tie straightening sort of answer is that credit is one’s ability to borrow money from a financial institution of some sort with the understanding an agreement is made to not only pay back the money borrowed in addition to an agreed-upon rate of interest— or money charged to borrow money. While this definition sufficiently describes what credit is, but it comes far from explaining how credit works. That answer is much more complex and can vary from person to person.

Is all credit created equal?

Of course not. There are four major credit account types available. There are revolving, service, and installment accounts as well as charge cards. Each of these accounts function slightly differently, and have different requirements on the borrower’s end as well as different regulations enforced on the lender.

C’s the Day

A general overview of how credit works is called the 4 C’s of credit. These four bullet points are what the majority of creditors base their decision on when you or I apply for financing of any sort. In short, the 4 C’s are: Credit History, Capacity, Collateral, and Conditions. These are confusing or even slightly scary. I know. In the next few installments of Making Cents, however, I am going to delve into each of these C’s individually to help you and I understand them more fully.