Credit cards 101

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What is a credit card?

In its most basic form, a credit card is an account issued by a financial institution that allows a consumer to purchase goods or services on credit, then repay the balance over time. It sounds simple; many factors determine how much credit you are granted and what it will cost over time.

To make this determination, a financial institution assesses your risk by using the following factors:

  • Ability to pay: the capacity to repay your current debts and support additional debt; this is why banks collect information about your income, assets, and current debt.
  • Stability: relates to the length of time you have supported other loan products, how long you’ve lived in one location, or the length and type of employment you have; this helps lenders understand how likely you are to encounter issues that may impact your ability to support your obligations.
  • Willingness to repay: based mainly on your credit history, this tells banks how well you’ve handled your previous and current debts, which is a strong indicator of how well you will manage new obligations.

The lower the risk, the more credit and institutions may grant you, and the lower your interest rate will be for paying back your balance.

What is a credit rating?

When you apply for an account with a financial institution, they will request a copy of your credit report from one of the three major credit reporting agencies: Experian, TransUnion, or Equifax. Your credit report contains information about previous loan relationships: when you opened them, what they were for (mortgage, car loan, credit card, etc.), and how you handled the payments. When you have good credit, meaning you’ve demonstrated that you have handled debt responsibly in the past, you receive a high credit rating or score, which can improve your chances of being approved for new loans and getting a lower interest rate on those loans.

When you open any loan account with a financial institution (credit card, mortgage, car loan, student loan, retail charge card, etc.), the lender is responsible for reporting that information to the three credit reporting agencies. The information reported includes items such as:

  • When the account was opened
  • The amount of credit granted (your credit limit) and the current balance
  • The current payment status of the account (are you currently past due or over-limit)
  • Your delinquency history (how often have you been past due and how long ago)
  • The account status (open, closed, in dispute, charged off, etc.)

The information reported to the credit reporting agencies is used to determine your credit rating or score. Most creditors report account information monthly, although the timing may vary slightly from creditor to creditor. Likewise, individual creditors’ practices around reporting account information on authorized users or the timing of reporting may vary, so it’s best to seek that information directly from your lender. For instance, many lenders do not report an account as delinquent until two payments have been missed, but you shouldn’t assume that all creditors follow the same practice.

Click here to contact the loan experts at Elite Financials for further assistance. Good luck!