What Is Credit? Definition & How It Works

By Robin Hartill, CFP – Updated Jun 15, 2025 at 12:10 AM

Key Points

Credit is a binding agreement to pay back borrowed money plus interest.
Types of credit include secured (like mortgages) and unsecured (like personal loans).
Credit scores, used in lending decisions, are based on payment history and debt levels.

Credit is an agreement where you get money or something of value immediately with the promise that you'll pay back the full amount you borrowed (usually, plus interest) in the future. Credit cards, loans, mortgages, and buy now, pay later (BNPL) are all types of credit. We'll explore how credit works, the various types of credit, and how credit is measured.

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A person holding about 10 credit cards and choosing one. — Image source: Getty Images.

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Credit Score

A prediction of your borrowing behavior, such as how well you pay off your debt.

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Credit scores are calculated using the information compiled in your credit report. There are many different credit scoring models, but FICO scores are by far the most common. In fact, FICO says its scores are used in 90% of lending decisions. FICO weights the five factors in determining your score:

Payment history (35%): Payment history is your track record of making on-time payments and whether you've had accounts sent to collections. It's the most important credit scoring factor.
Amounts owed (30%): The amount you owe relative to your open credit is another credit. A common recommendation is to keep revolving credit balances below 30% of your limit if you want a good credit score.
Age of credit (15%): FICO weighs the age of your oldest account, your newest account, and the average of all your accounts. As you build a longer credit history, you'll often see your score increase over time.
Credit mix (10%): Having a mix of different types of credit, such as credit cards and installment loans, typically helps your score.
New credit (10%): FICO's formula factors in new credit applications you've filed in the past 12 months. That's why you'll often see your credit score drop by a few points if you open a new credit card or take out a loan. But as long as you don't apply for multiple lines of credit too quickly, the impact will typically be minor and short-lived.

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About the Author

Robin Hartill, CFP, is a contributing writer at The Motley Fool. Robin’s work has also been published by Yahoo Finance, USA Today, and Penny Hoarder. She is a graduate of the University of Florida.

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