Check your credit. Boost your credit. Repair your credit. It’s hard to get through a day without seeing a banner or hearing a commercial telling you how important it is to have good credit. If you’re unfamiliar with what that really means, you’re not alone. Here are some basics that may help you on your journey to building and maintaining good credit.

What Is Credit and How Does It Work?

“Credit” can actually mean a couple of things. It may be a contract between a lender and borrower that says you, the borrower, received a sum of money or something else of value that you need to pay back to the lender at a later date, sometimes with interest. A good example is taking out a car loan or buying dinner with a credit card. The financial institution that provided the loan or card has extended credit to you.

Closely related to that definition of credit is the one all those ads keep talking about. When they encourage you to build good credit, they’re talking about building your financial reputation — establishing your trustworthiness as a borrower by having a history of paying back money you owe, on time. If you have good credit, there’s a greater likelihood that a lender or credit card company will enter into a credit agreement with you.

Your credit history is documented in credit reports compiled by three credit bureaus: Experian, TransUnion and Equifax. Lenders share borrower information with these agencies to ensure that all lenders can see a potential borrower’s creditworthiness. In addition, a three-digit number — your credit score — helps lenders quickly determine how likely you are to repay a loan. Credit scores range from 300 (poor) to 850 (excellent), and fluctuate based on your financial activities, behaviors and circumstances (e.g., how much you owe and whether you make timely payments). When services offer to help you boost your credit, they are usually talking about your credit score.

Why Is Credit Important?

Building and maintaining a healthy credit score and history is important because the quality of your credit can have far-reaching effects on many aspects of your daily life. In addition to lenders and credit card companies checking your credit, insurance companies, landlords, utility providers and even potential employers may check your credit. 

Your credit can influence whether or not you are able to rent the apartment you want, how much you pay for insurance, the credit limit on your credit cards, the interest rate you pay when you take out a car loan or mortgage, and many other things. (Employers tend to check a candidate’s credit report when they are up for a position where they would be managing a budget. If a person hasn’t done a good job managing their own finances, the employer isn’t likely to give them that type of job.)

What Are the Different Types of Credit? 

Going back to the first definition of “credit” — the contract between a lender and borrower — let’s look at the different types of credit that may be available to you:

Installment loans. Student loans, personal loans, car loans, mortgage loans and other installment loans enable you to borrow a set amount of money that you must pay off, plus interest and fees, within a specified amount of time, through set monthly payments. 

Revolving credit. If you have a credit card, then you may be familiar with revolving credit. The credit card company or financial institution sets a maximum borrowing limit, called your credit limit, up to which you may borrow (make purchases). You are obligated to make regular monthly payments of at least the minimum payment specified by the card issuer. If you do not pay your debt on time and in full each month, you may be charged a late fee and your outstanding balance will accrue interest charges.

Service credit. Companies that provide you with ongoing services — your internet provider, gas or electric company, and cell phone provider, for example — typically do so with the expectation that you will use the services today and pay for them later. Failing to pay can result in fees and discontinuation of the service. 

Any time credit is extended, it is in good faith that the money will be repaid according to the terms set forth by the creditor. If you accept credit but don’t hold up your end of the bargain, you could face financial penalties as well as a negative impact to your credit score and history. 

How Can I Build Good Credit?

Good credit is based in large part on being a responsible borrower — paying back what you’ve promised to pay back in the timeframe you’ve agreed to with your creditor. Here are some steps to help you keep your credit history clean and your credit score high:

Make on-time payments. This means paying your bills and making your loan payments ON time EVERY time. Missing a payment deadline can ding your credit score and make you appear unreliable as a borrower. 

Keep your credit card balances low. Your credit score is based in part on what percentage of your total credit limit you’re using. For example, if you have two credit cards — one with a $5,000 credit limit and the other with a $10,000 limit — your total credit limit is $15,000. If you have balances of $1,200 across those two cards, your credit utilization ratio is 8%. Keeping your credit card usage in the 1%-10% range is most beneficial to your credit score, but anything below 30% is generally considered good. 

Monitor your credit report. It’s important to regularly check your credit report for any errors or fraudulent activity, such as incorrectly reported payments or purchases made as a result of identity theft. In the event you spot an issue with your report, you can dispute it with the credit bureaus; if they confirm it was an error and remove it from your record, your credit score might get a positive bump! 

There are many services that allow you to check your credit report for free. Research to see which is the best fit for you. Many people visit annualcreditreport.com, which will provide you with a free report from each of the three reporting bureaus — Experian, TransUnion and Equifax — once every 12 months.