Why is credit important?

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In a Nutshell

Credit is a tool that can be used for good but may be problematic if you don’t know how to use it effectively. Using credit reliably and earning good credit scores can help you build wealth and allow you to do business with companies — but you can get into trouble if you don’t understand how credit works.
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People want things they can’t pay for all at once and credit makes it possible to obtain them.

Why is credit important and how can you get access to it when you need it? Let’s find out.

Why is credit important?

When consumers and businesses can borrow money, economic transactions can take place efficiently and the economy can grow. Credit allows companies access to tools they need to produce the items we buy.

Credit also makes it possible for consumers to purchase things they need. Many items, from cars to houses, are too expensive for most people to pay for all at once. With credit, it’s possible to pay over time while accessing essential products and services when you need them.

Loans can enable wealth-building by allowing people to do things like pay for college, increase earning power, buy a home and benefit from rising property values, or start a business, Ross says.

If unforeseen expenses arise or you need something you can’t afford, being able to borrow could be a lifesaver.

Accessing credit is important for another reason in today’s society: consumer credit reporting. When you borrow money, creditors often report your behavior to credit-reporting agencies. Data on your financial behavior is aggregated to create credit reports and evaluated to generate credit scores. Those reports and scores are used by lenders when they assess how risky it may be to lend to you.

Why is good credit important?

So why do your credit reports and credit scores actually matter?

Your credit scores affect your ability to get credit in the future.

If you mismanage your credit and earn a poor credit score, you’ll be less likely to qualify for loans or credit. Or you’ll end up with a loan with a high interest rate and poor terms and conditions.

But what if you don’t want to ever borrow and you’re committed to paying cash for your house, car and other big purchases? Even in these cases, having good credit matters, because credit scores are used for lots of things in the U.S.

Landlords may check your credit when deciding whether to rent to you. When you try to get a cellphone contract, your credit scores and reports are usually checked.

Your auto insurer also may take a look at your credit scores when deciding what rates you’ll pay. And your credit can even affect your job prospects.

What are the risks of credit?

Credit is a tool, and like most tools, it can be misused.

Since your credit scores are used to measure your reliability, inconsistent borrowing behavior and low credit scores will likely make people and companies reluctant to do business with you. You may not be able to get a cellphone contract without a large deposit, or a landlord may not rent to you.

Another big risk: borrowing costs money — in fees and interest — and it’s possible to borrow more than you can repay.

To avoid problems you should limit borrowing and take out loans only if you can easily repay them. It’s also important to distinguish between so-called “bad” debt — debt used to buy things just because you want them — and “good” debt, such as a mortgage or student loans that can help build wealth in the long term.

Bottom line

Getting by without credit can be difficult because the U.S. is a credit-based economy. Without the ability to borrow — and without a positive credit history — you may not be able to make big purchases like a home or a college education and benefit from the wealth-building that may result. But credit’s not the answer to all your financial problems; you need to borrow responsibly and use credit wisely to help, not hurt, your financial future.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbo… Read more.