When we rent a place to live, landlords often make a decision whether or not to rent to you based on your credit. So, what IS credit?
I like the definition in the Wikipedia entry for credit:
Credit is the trust which allows one party to provide money or resources to another party where the second party does not reimburse the first party immediately, but instead promises either to repay or return those resources at a later date.
Credit, then, is a measure of trust. In other words, "I will let you have the thing I'm selling now, because I trust you to pay me later."
In a simpler time, when people in your community knew who you were, you formed trust relationships and developed a reputation. The shopkeepers in town got to know you and your family and you got to know them.
So when you needed produce and meat for the week, but did not have the money to pay for it yet, the kind grocer may extend you credit to make the purchase. He may have known that you got paid every Friday, and trusted that you would pay him back. When you paid the bill in full and on time, as agreed, he might have extended you credit again in the future. He might even have given you more credit, allowing you to purchase more with your promise to pay. Why? Because he now trusts you - you did what you said you would do.
My own grandfather was the small town grocer in the above example (and his parents in the above picture) and he regularly conducted business in this way in the 1940s and 1950s.
But what happened if you did not pay in full and on time, as promised?
First, the grocer would probably lose his trust in you. Until you paid off what you owed, you would not be able to buy groceries on credit, only with cash. It may take a long time to reestablish the trust, and even then, he may hesitate to trust you as much as he did before.
Second, the grocer would likely talk to the owners of other businesses in town. This wasn't to be mean, it was for the merchants and shopkeepers to protect each other from financial loss. So, the hardware merchant, the baker and the pharmacist, all might know that you did not pay your grocery bill, so they too are cautious to extend you credit. This would hurt other merchants' measure of trust in you too, or your credit reputation.
In fact, this is how one of the 3 major credit bureaus got started - a grocery store in Tennessee compiled a list of its customers based on their creditworthiness.
As towns and communities grew in the 1950s - 1960s and people drove longer distances to stores, it became impossible to know every store customer. Merchants began to rely on your reputation (the trust other people had in you), instead of their own personal knowledge of you and your family. Eventually, this became the credit reporting system we have today.
Today, three major companies called credit bureaus (Equifax, Experian and Transwestern) do credit reporting on individuals. Each one assigns you a numerical score (a "credit score") to determine how much you should be trusted to borrow money. Merchants, banks, credit card companies and property managers use your credit score to determine the risk of lending money to you - or renting you an apartment.
If you have a low credit score (or no credit score at all), a property manager may decide not to rent an apartment to you, charge a higher deposit, or add on a monthly fee. Just like the grocer in the 1940s, the property manager has to trust that you will make your payments in full and on time. Your credit score is one of the best ways to determine that, especially in a world where we just don't know everyone personally.