The word ‘Credit’ has multiple meanings in the financial world. In a balance sheet, an accountant might refer to credit as an increase of liabilities while for individuals like us a credited bank account is nothing less than a blessing.
Well, there are several other meanings of this essential financial term and this blog is dedicated to understanding each of these. Before diving into deeper insights, let’s explore the definition of credit from a financial perspective.
Credit Definition
In general terms, Credit is referred to as an agreement between a lender and a borrower, where a lending company/bank gives away a sum of money for a person in need with certain terms and conditions and a predefined payback period.
The second major definition of credit is, it refers to the creditworthiness of an individual. You might have come across several terms like, creditworthiness, credit history, Credit score and all of them mainly refer towards how sound the financial position of an individual or a business is.
As discussed earlier, the third scenario is where credit is referred to as depletion of assets and an increase in the value of expenses or liabilities.
Credit is a powerful financial term and is among the most crucial factor in defining a venture’s financial success.
The concept of credit goes back to thousands of years and it existed when the world was not even introduced to the concept of currencies. During the dawn of human civilization, the credit system was used for the exchange of services and goods.
In the current world of finance, credit is accredited as a social relation between a lender and a borrower. During this social relation, the lender is termed the creditor, while the burrower is termed a debtor. The borrower is liable to accept the requirements defined by the lender while borrowing the sum of money. He must also pay back the interest alongside the burrowed amount at the predetermined period else, the borrower will be liable to pay penalties.
Over time, the concept of credit has evolved and in the modern world, credit cards have become the most common type of credit. However, the mechanism around which credit cards function hasn’t shown any notable differences.
The credit cardholders get the cards issued from the merchant (bank) and the bank extends credit to the credit card holder when he needs it. Later, the cardholder repays the merchant the full sum of money alongside the interest charge incurred in the meantime.
Importance of Credit
Credit has now become a vital element for the growth of an economy. As individual consumers and businesses borrow money, the transactions take place and the wheels of the economy keep revolving.
The concept of credit has saved several giant companies, even multiple countries from extinction. The basic purpose for people to rely on credit is, it allows the companies access the resources that they require to produce the goods.
Also, the giant industries wouldn’t have worked if the concept of credit didn’t exist. From acquiring heavy machinery to afford the bulk raw material and paying salaries to thousands of employees, the industries often rely on credit lenders to have their needs full.
Similar is the case of the individual consumers, they often consider credit to get their needs full. For major expenses especially, like buying cars and building houses is quite impossible without relying on credit.
Alongside helping us to get our needs full, credit also enables us to build wealth. From helping someone finance their dream venture to enabling a student to pay their college fee, credit tools help us in multiple ways.
Think of any emergency or any unforeseen expense, how would you cope with such scenarios? Most people have answered that they consider credit tools to get their financial needs filled in emergencies.
Over time, credit tools have also emerged as a parameter to measure the creditworthiness of any individual or a company. As an individual or a firm borrows money from a lender, it gets registered with the credit-reporting agency. Based on how often you have borrowed money and how long it has taken for you to return the borrowed sum, credit-reporting agencies maintain your credit history.
This credit history is later used by lenders when an individual opts for larger mortgages and jumbo loans. So, in order to have a credit history, you have to count on the credit tools.
You may also want to read about 5 Best Budgeting Tips Everyone Needs To Know Now
The Bottom Line
For a credit-based economy like the US, it is essential for an individual to maintain a good credit history and it is only possible if you have the ability to borrow. However, it is worth mentioning here that ‘borrowing responsibly and using credit wisely’ is essential for your financial wellbeing.
