Credit

What Is Credit?

Credit is an arrangement in which a person, business, or government receives something of value now and agrees to repay it later, usually with interest. The most familiar form is borrowing money through a loan or credit card. Credit also includes trade credit, in which a supplier lets a buyer pay for goods after delivery. In accounting, the word has a separate, technical meaning: it refers to the right-hand side of a journal entry.

How Credit Works

When someone applies for credit, the lender reviews their creditworthiness, which is an estimate of how likely they are to repay what they borrow. Lenders typically consider income, existing debts, and repayment history. In many countries, lenders also rely on a credit score calculated from credit report data. Based on this assessment, the lender decides whether to approve the request, how much to lend, and what interest rate to charge.

Credit comes in two common structures. Revolving credit, such as a credit card, sets a maximum balance that the borrower can use, repay, and use again. Installment credit, such as a car loan or mortgage, provides a fixed sum that is repaid on a set schedule.

Credit in Accounting

In double-entry bookkeeping, every transaction is recorded in at least two accounts, with debits on one side and credits on the other. Credits increase liability, equity, and revenue accounts, and they decrease asset and expense accounts. This is a bookkeeping convention rather than a judgment about whether a transaction is good or bad. Because the term has a different meaning here than in everyday speech, beginners often find it confusing.

Why Credit Matters to Investors

Credit is a source of risk for lenders and bondholders. credit risk is the possibility that a borrower will fail to make promised payments. Credit rating agencies assign a credit rating to bonds and issuers to summarize that risk. Investors often compare the yields of bonds with different ratings to judge whether the extra return justifies the added risk. Individual investors also encounter credit when they use margin accounts or when companies they own carry significant debt. Understanding how credit works helps explain why interest rates and bond prices move the way they do.