Understanding Credit Cards: What is Credit?

by Amy Lillard

Credit and credit cards are an integral part of our economic system today. But there is a lot of misinformation and misunderstandings about credit. In this continuing series, we examine key concepts, tips and best practices when it comes to credit cards.

(10/8/2012) Credit is a monumental player in our current economy. But the concept of credit has been around for much longer.

As long as there have been merchants with something to sell, individuals and families have been able to purchase items with a promise to pay at a later date. Before credit cards, credit could be a simple verbal agreement. A common example - people could pick up groceries for the week and pay when they received their next paycheck. If the bill wasn't paid, the local merchant could cut off the credit line.

Credit has become much more institutionalized and standardized over the years through the use of credit cards. They work off the same principle, only now credit is extended with the help of large bankers and other financial institutions. Consumers use credit cards as a loan if they'd prefer to pay for items at a later date or over time. Their lender provides funds to the merchant immediately, and then bills the purchaser, with or without interest.

Credit was always extended by merchants on the basis of trustworthiness. Business owners often knew their customers, and if they felt like they could be trusted to pay their bill in a timely manner, they would extend the courtesy of credit. Today, that personal connection is for the most part removed. But larger lenders still work off of the notion of trustworthiness, determined through a more mathematical and logical method of a financial formula.

The process of obtaining credit, then, is a little more rigorous and involves some paperwork. Lenders will formally examine your credit history, or how you have used credit in the past, to predict your behaviors in the future. They will also consider your income and capability to pay back what is owed.

If lenders are concerned about past credit problems, income, or a lack of credit in the past, they can still extend you credit with caveats. The lender may require a co-signer to help assume some of the risk. Alternatively, credit cards may be issued with small credit limits as a trial.

While credit has been around for a long time, the importance of credit to the overall economy has grown astronomically. Today, individuals are expected to use credit, and our increasingly complicated financial systems rely upon it. That's why its more important than ever to understand the concept, and your options.