As important as credit is to us in the modern financially controlled society in which we live, it is amazing how little most people actually know about what credit actually means. Most people understand credit has something to do with one's trustworthiness, but these days it is something much more complicated than that.
In the old days, most people lived in small towns and knew and were known by their bankers. There was no need for a credit rating or credit score to help bakers decide to what they would lend their money. As the nation grew and banks became larger, banking became much less personalized. Bankers no longer were intimate with their customer's reputations and needed a tool to use to judge a person's likeliness to repay a loan. The credit report was the solution to this problem.
There are a few common errors that people tend to make when it comes to understanding the factors that go into our credit rating and score. Here are a few.
Many people seem to think that having bad credit is worse than having no credit at all. Without your credit rating is absolutely abysmal, this is just not the case. Someone who has bad credit is at least a known entity. If you have no credit at all, you are actually unknown to modern society and are viewed as being just as great a risk if not greater than someone who has made some financial mistakes. The fact is that nearly everyone who has been involved in the financial system has made some mistakes that will reflect on their credit record. These mistakes can be corrected, but no history at all is a black hole that makes bankers suspicious.
If you never intend to use any form of credit in your life, then paying cash for everything is fine. But to establish a credit history, you must occasionally use credit. This is how you prove that you are reliable and know how to manage loans and repay them in a timely manner. The trick is to keep the debt to a manageable level that you are able to pay. Getting in over your head is where the trouble begins.
To prove you are responsible, you need to maintain your credit over a long term. Getting a loan and paying it off immediately is great, but it does nothing to demonstrate your ability to manage long term financial matters. Creditors want to judge your ability to manage debt over a long period of time. Take out a small loan and pay it off in installments over several months. A solid record of making consistent payments over the span of at least a year is optimal.
Credit reports have nothing that indicates when you pay more than the minimum in a given month. The only thing that matters is that you consistently make the minimum payment each and every month. Therefore it's better to pay only the minimum 6 months in a row than to make double payments for 5 months and then be a week late on your sixth month.
Consistency in paying your obligations is the most important factor in credit history. You will not be overly penalized for a few minor mistakes, but consistency over the long term is what creditors are looking for.