What Is Credit?

Here's the simple answer: Credit lets you borrow money from a bank or other institution. You then agree to pay back the borrowed funds within a specific period.

This credit arrangement shows up as your credit history. This, in turn, generates a credit report. That report details how you use your money, how many loans you have, and whether you pay everything off on time.

Credit checks are an unavoidable fact of life. Whether you take out a loan, sign up for a utility service, or rent an apartment, your credit information is made available.

Credit Reports and Credit Scores: Knowing the Difference "Credit reports" and "credit scores" aren't the same thing:

Your credit report contains credit activity information, loan-paying history, and credit account status. Three national bureaus – Equifax, Experian, and TransUnion – issue credit reports.
Your credit score is a three-digit number based on your credit report information. VantageScore and FICO generate these credit scores.
That’s not all. You likely don’t have a single credit score. You could have many credit scores, depending on the credit bureau's reporting criteria. Credit scores can also differ based on loan type or scoring models.

The goal should be to improve your credit score. A higher credit score means access to better loans with lower interest rates.

A Brief History of Credit Scores

Credit scores have been around since the 19th century. Merchants formed reporting agencies to measure business customers’ creditworthiness. Then mass retailing and installment payments became popular in the late 1800s. This required a system to ensure on-time payments. This led to the beginning of consumer credit scores.

From the 1930s to the 1960s, quantitative data supported credit scores. Department stores led the way, assigning "points" to assess customer creditworthiness. Industry consolidation also took place. This reduced the number of U.S. credit bureaus from 2,000 to the three used today.

However, credit scores and analyses were still subjective and unfair. In 1989, Fair, Isaac, and Company (FICO) introduced an objective credit scoring system. Department stores depended on FICO. Government-sponsored agencies Fannie Mae and Freddie Mac also relied on FICO scores to underwrite mortgages.

In 2003, Congress enacted the “Fair and Accurate Credit Transactions Act.” This allowed Americans to access their credit reports for free. Three years later, the three credit bureaus created VantageScore to compete against FICO.

How Are Credit Scores Calculated?

Your credit score depends on these factors:

Payment history: The percentage of on-time bill payments
Credit use or utilization: The debt you add versus your available debt
Credit history: How many accounts you have and how long they've been open
Credit mix: Types of debt, like student loans, mortgages, car loans, and credit cards
When a lender wants to view your credit score, they’ll either use a hard inquiry (or hard pull) or a soft inquiry (or soft pull). A hard inquiry means the lender examines your credit reports and credit scores in depth. Because of this, a hard pull could temporarily reduce your credit score.

A hard inquiry might take place if you respond to a pre-approved credit card offer. A hard inquiry could also occur if you request an increase in your credit line.

On the other hand, a soft inquiry doesn't impact your credit score. This is because a soft pull isn't attached to a specific credit application. A soft inquiry might occur if a future employer examines your credit report.