No More Confusion—20 Credit Terms Defined
If you’ve ever read a credit card or loan application, you probably encountered more than a few words that seemed to be written in a separate language. Credit terms can be descriptive and self-explanatory at their best, but also unclear and confusing at their worst. Especially given most of us don’t spend a lot of time perusing credit documents in our daily lives.
What follows are 20 common credit terms most everyone should be familiar with. Doing so will hopefully save you some time and head-scratching the next time you review your statement, think about getting a new credit card, or dive into an article about credit.
1. Annual Percentage Rate (APR)
This term—usually in its acronym form—is ubiquitous in the credit world. It is essentially the percentage of interest charged on your outstanding loan balance, expressed as a yearly rate.
APR differs from annual interest rate on certain loans, such as home mortgages, in that it also includes other costs/fees associated with the loan in its calculation. However, with credit cards, APR and annual interest rate are the same.
2. Authorized User
An authorized user is a person added to a credit card account who’s allowed to make charges. They get a credit card of their own with their name on it and are able to make purchases with the card up to its credit limit; however, authorized users do not have all of the same privileges as primary account holders.
An authorized user cannot be held responsible for paying any of the credit card’s bill—even the charges they made. The primary account holder is ultimately responsible for all authorized charges.
Activity on the account from both the primary account holder and the authorized user will be reflected on the primary account holder’s credit report. It may also show up on an authorized user’s credit report, depending on the credit card company’s policy.
3. Average Daily Balance
This balance is used by credit card companies to calculate interest. The average daily balance is the sum of the outstanding balance from each day of your credit card billing cycle dividing by the number of days in that billing cycle.
So, say, your billing cycle was five days long, and your outstanding balances at the end of each day of the cycle were as follows:
Day 1: $50
Day 2: $100
Day 3: $150
Day 4: $200
Day 5: $250
Your average daily balance would be $150 ($750 ÷ 5).
4. Credit Bureau (aka Credit Reporting Agency, Consumer Reporting Agency)
There are three main credit bureaus in the United States: Experian®, Equifax®, and TransUnion®. These agencies collect and document information provided to them by banks, credit card companies, and other financial institutions on the credit behavior of individual consumers.
They also sell this information in the form of credit reports to lenders in order to help them make better-informed decisions on granting credit.
5. Credit Utilization Ratio (aka Credit Utilization Rate)
Math is important in the credit world, and this ratio is used to express how much you owe in relation to how much available credit you have. The mathematical formula for calculating your Credit Utilization Ratio (CUR) is as follows:
CUR is used to calculate credit scores, accounting for up to 30% of your score. While there’s no hard-and-fast rule on what your credit utilization ratio should be, many experts recommend it be below 30%.
That little metallic square found in credit cards is actually an EMV computer chip. EMV stands for Europay®, Mastercard®, and Visa®, the three companies that originally created the standard for this technology to help make credit card transactions more secure.
Unlike magnetic stripes (aka magstripes) on credit cards that contain all of a card’s information, which can be used over and over if copied, EMV chips create a unique transaction code for each purchase, which cannot be used a second time. So, if a fraudster were to copy your credit card’s chip information from a particular point of sale, that information would not be usable to make future fraudulent charges.
7. FICO® Score
A FICO Score is a three-digit number used to assess the credit risk of a borrower, created by the Fair Isaac Corporation. This score ranges from 300 to 850 and is calculated using the following five categories:
• Payment History (35% of your score)
• Amounts Owed (30% of your score)
• Length of Credit History (15% of your score)
• Credit Mix (10% of your score)
• New Credit (10% of your score)
FICO Score is one of the two major models used to calculate credit scores, the other being VantageScore®.
A hard inquiry, also known as a “hard pull,” is when a potential lender checks your credit report because you’ve applied for credit with them. A hard inquiry may lower your credit score by a few points, and it stays on your credit report for up to two years.
Each credit check counts as a single hard inquiry, so too many hard inquiries over an extended period of time could lower your credit score and signal to potential lenders that you’re desperate for credit. However, if you’re shopping for the best rate or deal to finance a home, car, etc., multiple hard inquiries done within a short period of time—45 days for FICO—may be treated as a single hard inquiry.
“Installment” is the key word in this term, as it’s what differentiates this type of credit or debt from "revolving" credit. An installment loan entails borrowing a specific amount of money, which is paid back in payments of a set amount on a regular basis (usually monthly) over a defined period of time.
An example of an installment loan would be an auto loan, where, say, you agree to make a monthly payment of $500 over a set period of four years. Home mortgages and student loans are also examples of installment loans.
If you’re a borrower and miss making at least the minimum payment to your lender by the payment due date, you are likely to get hit with this fee, depending on the terms and conditions of the credit agreement you signed. Credit card late fees are regulated by federal law, and it’s worth noting that even if your payment is received on time but is less than the minimum payment, you may still be assessed a late payment fee.
In order to avoid a late payment fee, most lenders require payments to be received by the due date, not just postmarked by that date.
In addition to being hit with a fee, a late payment may also be reflected on your credit report and could adversely affect your credit score.
11. Minimum Payment
As the name makes clear, this is the minimum amount you can pay on a loan to make or keep your account current. Making at least the minimum payment on time may also help you avoid penalties and fees, such as a late payment fee.
Even if you make a partial payment on time, if you fail to pay at least the minimum payment amount, you are technically past due, and your lender may report you to the credit bureaus as such.
12. Return Payment Fee (aka Returned Check Fee)
If you make a payment by check, and your check bounces, you may be assessed a return payment fee by your lender. You may also be hit with an additional fee by your bank for writing a check with insufficient funds to cover it.
“Revolving” is the key word in this term, as it’s what differentiates this type of credit from “installment” credit or debt. You can use this type of credit repeatedly, up to your credit limit, so long as the account stays open and you’re making on-time minimum payments.
A credit card is an example of revolving credit. So are personal and home equity lines of credit.
14. Rewards Card
As an incentive for you to spend more with their credit card, many companies offer these types of cards, which reward you for every purchase made with their card. These rewards can include cash back; airline miles; or discounts on gas, hotel rooms, utilities, and more.
A rewards card is an excellent way to earn bonuses just for making everyday or recurring purchases. However, it may not make sense if you’re paying more in fees or interest than you’re earning in actual rewards.
This type of credit card requires the card holder to “secure” or back it with collateral, typically a cash deposit equal to the card’s credit limit. Secured credit cards are mainly targeted at consumers with no or poor credit and can be useful in establishing and building a credit history.
As it pertains to credit cards, this is the act of electronically stealing credit card information, which is subsequently used for fraudulent activity.
Criminals typically place a skimming device over a credit card reader, say, at a gas pump, which copies the card’s information. They then take that information to make fraudulent online charges or to clone bogus credit cards.
17. Soft Inquiry
Also known as a “soft pull,” this is a check on your credit report that, unlike a hard inquiry, does not affect your credit score. Soft inquiries are not a result of you directly applying for credit. They are usually done without you even knowing about them, typically by credit card and other financial companies to see if you qualify for their products before sending you an offer.
18. Unsecured Debt
This is a loan that doesn’t require any form of collateral. Examples of unsecured debt include credit cards (excluding secured credit cards), student loans, utilities, and rent.
Unsecured debt differs from secured debt, which is backed by collateral, such as a home or car. A car loan and home mortgage are both examples of secured loans.
A VantageScore is a three-digit number used to assess the credit risk of a borrower. It was created by the three major credit bureaus, Experian, Equifax, and TransUnion. This score ranges from 300 to 850 and is calculated using the following categories:
• Payment History (28% of your score)
• Amount of Recent Credit (30% of your score)
• Utilization of Current Credit (23% of your score)
• Size of Account Balances (9% of your score)
• Depth of Credit (9% of your score)
• Amount of Available Credit (1% of your score)
VantageScore is one of the two major models used to calculate credit scores, the other being FICO® Score.
20. Zero Fraud Liability (aka Zero Liability)
This is a policy adapted by some credit card companies that extends protection against fraudulent charges beyond what’s federally mandated by law. The Fair Credit Billing Act (FCBA) limits a consumer’s liability for fraudulent credit card charges to $50. Zero liability policies reduce a consumer’s liability to $0 if their card or card information is stolen and used to fraudulently purchase goods or services.
Some companies also apply this policy to debit cards, which are protected at different amounts than credit cards, depending on when any fraudulent charges are reported.