It's counterintuitive that in order to borrow money you should already be in debt.
Banks and lending institutions need to see the credit history of anyone asking to borrow money, the borrower's ability to repay (income), available collateral (to ensure reimbursement), the purpose of the loan and current debt.
Although most people consider "debt" to be a four-letter word, there is such a thing as good debt. Any loans taken out for advancement, like education, or money-making ventures, are included in the category of good debt so long as payments are up to date with a history of on-time payments; anytime you fall behind in your payments, you are risking losing the label of "good" debt.
When a lender examines your credit history and sees an educational loan that is on schedule or ahead of schedule, for example, it will be viewed more positively than a balance on a clothing department store charge or high-interest credit cards. Business loans for a steadily growing business will also be viewed in a nicer way than a car loan or a loan for a wedding reception. Real estate loans for investment properties have built-in collateral for repayment of the loan (or equivalent value) as well as the potential to make money; these qualify as good debt.
Financial organizations need to assess more than the borrower's repayment history, they will also measure the amount of already outstanding debt versus free income, the number of inquiries into credit by other lenders, and they will assess the guarantee that they will not suffer losses if the borrower does default. Having too many credit lines, even if nothing is owed, will be viewed as adverse credit.
An inquiry into your credit history will show attempts to get loans or credit. If credit was denied, then it becomes a negative. Some existing lenders periodically examine a customer's credit rating when reviewing accounts; some employers check the rating before hiring; and some mortgage companies may prequalify a candidate before actively looking for a house; these are called "soft inquiries" and rarely have any effect on the credit rating.
Consumers can and should check their own credit rating every so often. Federal guidelines permit consumers a free credit report each year; call Annual Credit Report at 877-322-8228, or go to AnnualCreditReport.com. It is also recommended to check your rating if you have applied for and been denied a loan. Ask the lender to tell you which company they used to make their determination.
The most common credit reporting agencies in the U.S. are Experian, Equifax and TransUnion. Consumers can contact these companies to get copies of their credit report to verify that there are no mistakes, check personal information (name and address) and find potential negative information (making sure disputes and paid-in-full accounts are recorded accurately).
There are also companies, some of them free, that will contact all the credit reporting companies for one comprehensive report. Report any inaccuracies in writing with proof and ask for immediate correction. Your resulting credit score represents the assumed risk a lender takes in extending you credit.
Most people need to borrow money to purchase a home, pay for college, or make otherwise large purchases. It's important to have a favorable credit history for bank loans, mortgage companies and potential employment. Young adults or people who are new to this country (credit histories do not transfer between countries) need to establish credit. Secured loans or credit cards showing low credit lines and on-time payments are among the easiest ways to build a credit history.
And remember that if you fail to pay, good debt quickly goes bad.