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What Is Credit?

Credit begins with you, the debtor. If you wish to purchase something now and pay for it later, one way is to apply for credit with a creditor (or lender). Your payment history is then reported to the credit bureaus by your creditors and becomes part of your credit report and score. There are many types of credit available, but most fall into two basic categories:

  1. Secured Credit: secured credit involves, you guessed it, security. The credit is secured with real property—like a house, a vehicle, or some other tangible asset—and the lender is protected if you should default on your loan. Under default, they can repossess the property tied to the loan. Secured credit usually comes with lower interest rates and longer terms because it's less risky for a lender.
  2. Unsecured Credit: unsecured credit is backed only by your promise to repay the debt. The lender faces greater risk and for that reason unsecured credit usually comes with higher interest rates and shorter terms. Most credit card accounts, signature loans, and lines of credit fall into this category.

In order to determine whether you are a good credit risk, the lender conducts a credit check by contacting one of the three major credit bureaus: Equifax, Experian, or TransUnion. Besides the "Big Three" credit bureaus, there are many other specialty credit bureaus, but for the most part creditors obtain consumer credit information from one or more of the three major bureaus. The credit bureaus provide lenders with a credit report that contains information on your credit and payment history along with a credit score. A credit score is a numerical rating based on the information on your credit report, and is used to quickly tell the lender how likely you are to default on a loan.

As you can now see, your credit report and credit score makes all the difference in whether or not you will be approved for a loan, and under what terms. Since 70 — 90% of all credit reports include some number of errors, the government has created legislation allowing you to dispute incorrect, outdated, and/or incomplete information. In addition, agencies were created to regulate and oversee the industry as a whole—both the reporters of credit information and the credit bureaus themselves. Guidelines for regulating the industry and protecting your rights are spelled out in the Fair Credit Reporting Act.

> What Is the Fair Credit Reporting Act?