Two easy ways to understand credit report rating.
At one time, in a charming town called Creditville lived a group of hardworking, happy folks. They were always looking for new ways to make their lives simpler and more convenient. One day, an intelligent merchant named Mr. Cashless introduced the people of Creditville to a fantastic creation: the credit card and its system.
Now, how does this credit card system work? Have you ever wondered how the credit card system works? If so, you’re in the right place.
In this blog, we’ll plunge deep into the inner workings of credit cards and explain how it all works in a rhythmic structure. You’ll learn about the components of a credit card, how they are used to make purchases, and why they are so crucial to businesses and Creditville citizen’s everyday life. We’ll also discuss some key benefits of using credit cards, summarizing everything you need to know. So let’s get started!
Penny’s Story
Now, let’s find out by following the journey of Penny Shopper, a resident of Creditville, as she discovers the magic of credit cards.
Penny’s Adventure Begins
Penny Shopper was a cheerful, kind woman who loved shopping at the local market and malls. One sunny day, she noticed a sign: “Welcome to Mr. Cashless’s store – where you can shop without cash!” Intrigued, Penny decided to check it out.
Inside, she met Mr. Cashless, who explained that customers could use a credit card to pay for their purchases. Penny was fascinated and very excited to discover something unique. She then decided to get her very own first credit card.
The Birth of Credit Cards
Before Penny could start using her credit card, she needed to learn how it came to be. Mr. Cashless explained that credit card companies, like the Bank of Creditville, issue credit cards to people who apply for them. To get a credit card:
- Penny had to fill out an application.
- The bank checked Penny’s credit history to see if she had a good record of paying back loans.
- However, based on her credit history, the bank decided whether to approve or deny Penny’s application.
Penny had always been responsible with her money. Hence, the bank approved her application and sent her a shiny new plastic or metal-looking card with her full name, card number, expiration date, and security code(CVV behind the card).
The Magical Power of Credit Cards
Penny couldn’t wait to use her new credit card. Mr. Cashless explained to her that credit cards have extraordinary power: they allow individuals to buy things or goods and services now and, in return, pay for them later. This system represents “buying on credit.”
The bank gives Penny a credit limit, which is the maximum amount she can spend on her credit card. Penny can buy whatever she wants as long as she doesn’t exceed that limit!
But with great power comes great responsibility. Penny needs to pay back the money she spends on her credit card. Every month, the bank sends her a statement showing how much she spent, and she needs to pay the total or at least a minimum amount. Now the bank has an interest fee on Penny’s magical card to make a profit. If she pays off her balance in full every month, she won’t have to pay any interest. But if she only pays the minimum, she’ll have to pay interest on the remaining balance.
Penny’s First Credit Card Purchase
Penny was excited to use her new credit card and went shopping at Mr. Cashless’s store. She picked out a beautiful dress and handed her credit card to Mr. Cashless. He swiped it through a magical machine called a credit card terminal.
This terminal sent a message to the Bank of Creditville asking permission to charge Penny’s card. The bank checked to ensure Penny had enough credit limit and then sent back an approval. The transaction was successful, and with a smile, Penny walked out of the store with her new dress, feeling very pleased with her credit card.
The Invisible Helpers
Penny didn’t see the invisible helpers working behind the scenes to make her credit card purchase possible. These helpers are called the “credit card system.” Here’s how they work together:
- The Cardholder: That’s Penny! She’s responsible for using her credit card wisely and paying her bills promptly.
- The Merchant: This is Mr. Cashless, who accepts credit card payments at his store.
- The Bank of Creditville authority of Credit lines and purchases
Timmy’s Story
Sometimes, in a friendly, well-known town called Scoresville, a group of people always wanted to be responsible with their money. One day, a wise financial expert named Ms. Moneywise visited Scoresville and taught the townspeople about a vital number called the “credit score.”
How does this credit score work? Let’s find out by following the journey of Timmy the Turtle, a resident of Scoresville, as he learns the secrets of credit scores from Ms. Moneywise.
Timmy Discovers Credit Scores
Timmy the Turtle was a hardworking and responsible turtle who lived in Scoresville. One day, he heard about a special gathering where Ms. Moneywise would teach everyone about credit scores. Timmy was curious and decided to attend the event.
Ms. Moneywise explained that a credit score is a number that helps lenders decide if someone is a reasonable risk for loans or credit cards. She told the audience that a high credit score means a person is responsible with their money, while a low credit score means they might have trouble paying back loans. All credit scores are measured using a system called a FICO score.
A FICO score, created by the Fair Isaac Corporation, is a three-digit number representing an individual’s creditworthiness based on their credit history and financial behaviors. Ranging from 300 to 850, having higher scores indicate better creditworthiness. Lenders use FICO scores to assess the risk of extending credit to borrowers. The Fair Isaac Corporation develops and maintains the FICO scoring model, but credit data comes from the three major US credit bureaus: Equifax, Experian, and TransUnion. FICO is just one credit scoring model, with others like VantageScore also assessing creditworthiness. Lenders may use different models based on their preferences and requirements.
The Credit Score Ingredients
Timmy wanted to know how his credit score was calculated. Ms. Moneywise explained that there are a few critical ingredients that make up a credit score:
- Payment History: This is the most crucial ingredient. It shows whether you’ve been paying your bills on time.
- Amounts Owed: This tells lenders how much money you owe compared to your credit limits.
- Length of Credit History: The longer your credit history, the better your score will be.
- Types of Credit: A mix of different types of Credit, like loans and credit cards, can help improve your score.
- New Credit: Opening too many new accounts in a short time can hurt your score.
Timmy’s Journey to a Better Credit Score
Timmy decided to improve his credit score to have a better chance of getting loans and credit cards in the future. He asked Ms. Moneywise for advice on how to raise his score. She shared these helpful tips with Timmy:
- Always pay your bills on time.
- Use only a little of your available Credit.
- Keep your old credit accounts open to show a more extended credit history.
- Only open a few new accounts at a time.
Timmy Sees His Credit Score Soar
Timmy followed Ms. Moneywise’s advice and paid his bills promptly. He also stopped using too much of his available Credit and didn’t open any new accounts. As a result, his credit score started to soar!
Timmy checked his credit score a year later to see how much it had improved. To his delight, his score had gone up by 100 points! Timmy felt proud of his hard work and knew that his higher credit score would help him achieve his financial goals.
The Benefits of a Good Credit Score
With his higher credit score, Timmy discovered many benefits. These included:
- Lower interest rates on loans and credit cards.
- Better chances of getting approved for loans and credit cards.
- Higher credit limits.
- Better insurance rates.
Now that Timmy knew the secrets of credit scores, he shared his knowledge with his friends and family in Scoresville. They all worked together to improve their credit scores and enjoyed the benefits of being financially responsible.
Ultimately, the people of Scoresville lived happily ever after, knowing that their good credit scores would help them achieve their dreams.
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