What Are Traditional and Nontraditional Types of Credit?

Credit is a contractual agreement where a borrower receives value with a promise of future repayment. This arrangement enables individuals to acquire goods, services, or funds before they have the full amount available. Credit also refers to an individual’s borrowing history, reflecting their ability to manage and repay debts responsibly. Building a strong credit history can significantly influence financial opportunities.

Traditional Credit

Traditional credit refers to borrowing options commonly provided by established financial institutions like banks and credit unions. These arrangements involve formal agreements, interest payments, and consistent reporting of payment behavior to major credit bureaus. This regular reporting is fundamental for establishing a credit history and generating a credit score, which lenders use to assess creditworthiness.

Credit cards are a common type of traditional credit, functioning as a revolving line of credit. This allows you to borrow up to a set limit, repay what you owe, and borrow again as needed, with interest accruing on outstanding balances. Mortgages represent secured installment loans for purchasing real estate, where the property serves as collateral. Auto loans are another form of secured installment credit for vehicle purchases, with the vehicle acting as collateral. Personal loans can be either secured or unsecured installment loans, providing a lump sum repaid over a set period with fixed payments.

Nontraditional Credit

Nontraditional credit encompasses various borrowing methods that are less formal than traditional options. These often do not involve major financial institutions or consistently report to all major credit bureaus. Individuals often seek these options when they have limited or no traditional credit history, or when they need immediate, short-term funds. While some nontraditional credit activities can influence credit history, many do not contribute to building a traditional credit score in the same way as conventional credit.

Types of Nontraditional Credit

Buy Now, Pay Later (BNPL) services allow consumers to purchase items and pay in installments, often interest-free if payments are on time. They typically require a small down payment, with the balance paid over a few weeks or months.
Rent-to-own agreements permit individuals to lease goods or homes with a later purchase option. A portion of the rent paid may be applied towards the purchase price.
Payday loans are short-term, high-interest loans designed to be repaid on the borrower’s next payday.
Pawn shop loans are secured loans where an item of value, like jewelry or electronics, is used as collateral. If the loan is not repaid, the pawn shop keeps the collateral.
Title loans are secured by a vehicle’s clear title, allowing the borrower to keep driving the car while repaying the loan. These loans often carry high interest rates and short repayment terms.
Rent and utility payments can sometimes be reported to credit bureaus, providing a nontraditional avenue for individuals to build a credit history.

The Role of Credit Reporting

Credit reporting agencies, also known as credit bureaus, collect and maintain extensive financial information on individuals. The three major nationwide credit bureaus are Equifax, Experian, and TransUnion. Lenders, especially those offering traditional credit, report borrower payment behavior and account statuses to these agencies. This reported information forms the foundation of a credit report, which details an individual’s borrowing activity.

What’s in a Credit Report?

A credit report typically includes:
Payment history, indicating whether payments were made on time or were late.
Amounts owed, including credit utilization (the percentage of available credit being used).
Length of credit history, reflecting how long accounts have been open.
New credit applications, such as recent inquiries.
Types of credit used, such as a mix of installment and revolving accounts.

This comprehensive data is then used to generate a credit score, a numerical representation of creditworthiness that helps lenders assess risk and determine loan terms.

Accessing and Understanding Your Credit Information

Federal law grants individuals the right to obtain a free copy of their credit report every 12 months from each of the three major credit bureaus: Equifax, Experian, and TransUnion. The official website to request these reports is AnnualCreditReport.com. You can request all three reports at once or space them out throughout the year to monitor your credit consistently.

Reviewing Your Credit Report

When reviewing your credit report, it is important to:
Verify the accuracy of personal information, such as your name and address.
Check for the correctness of account details, including account numbers, credit limits, and loan balances.
Examine your payment history to identify any missed payments or errors that could negatively affect your score.
Look for any unfamiliar accounts or inquiries that might indicate fraudulent activity.