What Is Credit and Why Do You Need It?

Key takeaways:

Credit is defined as an arrangement that allows you to borrow money now and repay it later.
If you have good credit, it’s easier to borrow money from banks and other institutions.
You can build your credit over time.

The definition of credit is the ability to borrow money with the promise that you’ll repay it in the future, often with interest. You might need credit to purchase a product or use a service you can’t pay for immediately.

While credit comes in many forms, the most common are credit cards and home and car loans. You must apply for credit, and the amount you’re authorised to use is determined by lending institutions (like banks or mortgage companies) based on your personal financial history and patterns.

Having good credit makes it easier to do many things, like apply for a better credit card, rent an apartment or buy a home or car. With good credit, you can save money in the form of lower interest rates or waived fees and down payments when setting up utilities.

Credit definition

Credit can mean either borrowing money or getting something of value, like a car, with the commitment to repay later and often with interest charged. It can also mean your ability to borrow or buy things on a credit contract.

Your credit report and credit score are two ways your access to credit is defined.

Your credit report contains a history of your financial behaviour, as well as personal information like your employer and current and previous home addresses. The report lists:

The number of open accounts you have, along with the current balances.
Your payment history, including any late or missed payments.
Loans you’ve taken out and the remaining balances.
Any financial disruptions like bankruptcy or foreclosure.

Financial institutions can report your activity to some or all three of the major credit bureaus in Australia: Equifax, Experian and Illion (formerly Dun & Bradstreet). You can get your free credit score through one of those credit reporting agencies or via a provider listed on CreditSmart.org.

Monitoring your credit reports and looking for discrepancies is a good habit to practice. If you find an error, you can dispute it with the credit bureau. If the agency rules in your favour and fixes the error, this could have a positive impact on your credit score.

Your credit score is a number ranging from 0 to 1,000 or 1,200. Each agency has its own scoring model, so you might have a different number with Equifax and Experian, for example. It reflects your credit history and other components of your credit report, such as the amount of money you’ve borrowed and whether you make on-time payments. It distils this information into a shorthand used by financial institutions to determine your creditworthiness.

Types of credit

There are many types of credit, but two are most popular: revolving and instalment credit.

Revolving credit

Revolving credit is a type of credit typically issued in the form of a credit card, where users are given a credit limit but can spend as much or as little up to that amount as they want. Balances are paid off in full or in part each month, and any remaining balance is carried over (or revolved) to the following month. Credit cards are different from charge cards — another type of credit — where the balance must be paid in full each month.

Instalment credit

Instalment credit is a type of credit, usually issued as a loan, that borrowers pay back in steady increments over time. Examples of instalment credit include car loans and home loans.

Service credit

Service credit is a type of credit that describes contracts you enter into with many service providers, like utility companies and membership services. These companies provide the service, and you sign a contract to pay them after the fact. Your mobile phone plan, utility bills and gym membership all fall into this category.

How to build your credit

Whether you’re starting from scratch or want to build stronger credit, here are a few strategies to get you going.

If you don’t have credit but are looking to build it

Take out your own phone plan. Getting your own postpaid mobile phone plan and paying the bills on time will add positive information to your credit report. It’s an easy, manageable way to start building credit. While you’re at it, set up auto payments, so you never miss a bill.
Become an authorised user on the account of a trusted family member or spouse who has a long, responsible credit history. By having your name attached to their utility bill or line of credit, you can reap the benefits without worrying about the responsibility of payment.
Try a credit-builder loan. With these, lenders (frequently community banks and credit unions, in this case) hold the money you pay in an account until the full amount is repaid, then release it back to you.

If you have credit but want to strengthen your score

Apply for the right credit card. While most credit cards require applicants to have a good credit score, it is still possible to get a credit card with bad credit. Just make sure you’re comfortable committing to the payments.
Be sure to make payments on time. Make at least the minimum payment to avoid being hit with a penalty for a missed payment.
Keep your credit utilisation low. This refers to the amount of your credit line you’re using. Under 30% is good, but less than 10% is ideal.
Keep credit accounts open, especially your most long-standing accounts. Your credit history takes into account your average account age, so it’s a good idea to keep your first credit card open (even if you don’t use it much now).
Don’t apply for too many lines of credit at once. NerdWallet recommends spacing credit applications about six months apart to limit credit enquiries.