How to Buy a Car: What is Credit?

Let’s talk about credit. It’s a word that gets thrown around a lot but most people don’t have a good understanding of what it means. And if you want to get a car loan, you’ll do better if you know something about the subject.

What Exactly is Credit?

When people use the term “credit,” they’re actually talking about one of two things.

In a simple sense, credit is what someone gives you when they allow you to pay for something later instead of now.

When the power company allows you to pay for your electricity after you use it, they’re extending you credit. When a bank gives you a credit card that allows you to actually pay for purchases when the bill comes, they’re extending you credit.

And when a lender gives you a car loan to buy a car now but pay for it over time, they’re extending you credit.

Then there’s the other way people use the term “credit.” In this way, they’re really talking about their credit history or credit score.


Your Credit History

How good are you at managing your money? That’s what all creditors, including people who make car loans, want to know about you.

You see, a creditor’s top priority is to get their money back, or get paid for the services they’ve already provided. What they try to do before extending credit is make some sort of judgment on how likely that is to happen.

That is, they want to assess the risk of lending money.

The best way to assess what kind of risk you are is to look at how you’ve managed your money in the past. Your credit history.

They look for things like whether or not you’ve consistently made payments on time, or if you have outstanding bills that you haven’t paid at all. They’ll also look at how much you owe to all your creditors combined compared to how much you make.

How do they find this information?


The Three Credit Bureaus

There are three consumer credit reporting bureaus that keep records of your credit history: Equifax®, TransUnion®, and Experian®.

All three try to get as much information as possible about your bill-paying habits, although it’s pretty common that they’ll each have at least some different information.

They also try to keep tabs on how much you make, where you work and have worked in the past, where you live, and how long you’ve been there. Even though these things aren’t a direct reflection of your money-management skills, they are often related.

The longer you’ve been at one job or one address, the more stable you tend to be. The more stable you are, the more likely you are to pay your bills when they’re due. And all that means lower risk.

Most creditors will look at this information to decide if you are a good credit risk. It can be a lot of information to sort through, so they came up with a shortcut.

Next week we’ll talk about your credit score and what that means.