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Understanding credit

Credit means borrowing money and repaying it over a certain period of time with interest added. There may be many instances where borrowing credit will come to use but it's important to stay mindful as it can get challenging to repay, especially if you're taking credit for everyday expenses.

Taking credit makes sense if you are planning to:

  • borrow money to pay for a car repair or get your home renovated

  • buy your own home or apartment

Applying for credit

You can apply for credit in your bank or with another lender when you're in need of money. All financial institutions have to lend responsibly; however whether or not they lend money to you and the interest rate on credit will depend on several factors, like:

  • Reason for borrowing

  • Credit amount

  • Interest rate

  • Repayment period

  • Overall economic conditions

Your credit history

Before banks and other lenders decide to lend money to you, they will access your credit history and give you a credit score based on your previous interactions. This score indicates how much credit you can borrow and how reliable you will be at repaying. 

It is important to check your credit score regularly to ensure that it's reported accurately. There are several benefits of checking your credit score and maintaining a good score:

  • Your credit score will give you an indication about whether or not you will be able to secure credit easily

  • You can make sure that all the information that lenders are using to assess your creditworthiness is up to date and accurate

  • If you see transactions, accounts or borrowing that you don't recognise, it could be an indication that you are a victim of identity theft or fraud

Your credit rating is scored on several factors, like:
Positive reporting
Negative reporting
  • Your history of repaying credit consistently and on time
  • Your levels of unused credit
  • The infrequency of your applications for credit
  • The number and frequency of late credit card and other credit repayments
  • The amount (%) of credit in use
  • The frequency of your applications for credit
Your credit rating is scored on several factors, like:
Positive reporting
  • Your history of repaying credit consistently and on time
  • Your levels of unused credit
  • The infrequency of your applications for credit
  • Your history of repaying credit consistently and on time
  • Your levels of unused credit
  • The infrequency of your applications for credit
Negative reporting
  • The number and frequency of late credit card and other credit repayments
  • The amount (%) of credit in use
  • The frequency of your applications for credit
  • The number and frequency of late credit card and other credit repayments
  • The amount (%) of credit in use
  • The frequency of your applications for credit

How to improve your credit score

Here are five steps you can take to improve your credit score:

  1. Check your credit score/report regularly, and report anything that you think is wrong, or looks suspicious, straight away.

  2. Make repayments on time, including credit card and debt payments, as well as regular payments like your utility bills

  3. Stay within your credit limit, and try to keep your credit utilisation (in other words, the amount of your available credit you are using) as low as possible

  4. Avoid excessive change if possible. Keeping at least one bank account with the same provider, and living at the same address for an extended period, demonstrates the stability that lenders like to see

  5. Aim to clear high levels of existing debt before applying for further credit

Choosing the appropriate form of credit

Selecting the appropriate credit to apply for may depend on whether you are looking to borrow for short, medium or long term.

Short term debt;

Short term debts are ideal for covering your day-to-day expenses till you get paid next or for unexpected expenses like a car repair or home repair. The following types of credit are typically used for short term debts:

  1. Arranged overdrafts

    Arranged overdrafts let you continue spending money from your bank account, even when there is no money left in it, for something unexpected or extra spending. You will have to agree upon an arranged overdraft limit with your provider – which is the maximum amount that can be borrowed. There will usually be interest on your overdraft, although sometimes you will have an initial, interest-free overdraft limit.

  2. Credit cards

    Credit cards are perfect for borrowing small amounts of money for a short period. With credit cards, you can buy or pay for things now, and then repay that money at a later date, in instalments or in full. You will at least have to make a minimum payment each month - which is usually a percentage of what you owe. If you don't repay the amount you owe in full each month, you will be charged interest. You'll have a credit limit, which means you can spend as much as you need on the card up to that amount.

    Credit cards help you spread the cost of regular or one-off purchases. If you don't have an emergency fund, credit cards can also act as a backup to cover unexpected expenses.

    Remember that the amount you owe - money you've spent on the card, plus interest - can mount up if you're not careful. Ensure you pay back as much as you can every month as the more you pay back, the less interest you'll be charged.

  3. Payday loans

    Payday loans, also known as book up loans, are a type of short-term credit designed to tide you over until your next payday. Usually, you will have to pay back the loan in full the day you get paid. These types of loans often carry a very high interest rate and should be avoided if possible.

    Short term debt solutions may be risky because they typically carry much higher interest rates. Where possible, try to avoid using short term debt solutions when covering unexpected expenses.

Medium term debt;

Medium-term debts are ideal are expenses such as buying a car, paying for a holiday or for home improvements, where it might be helpful to be able to spread the cost of a purchase. The following types of credit are typically used:

  1. Bank or other loans

    A loan is where you borrow a set amount of money for an agreed period. You can pay back the full amount - usually in monthly instalments - plus interest. They may also be used to consolidate multiple debts into one. With a single monthly repayment and interest rate, this may make debts easier to manage.

    Note that spreading your payments over a longer period means you may end up paying more overall.

  2. Credit cards

    Used carefully, certain medium term commitments can be funded using a credit card - ideally, one that charges a particularly low interest rate for a defined period, or even no interest at all.

Long term debt;

Long-term debts are ideal for big expenses like building or purchasing a home. For substantial, long term debts like this, a mortgage is the most commonly used type of credit.

  1. Mortgage

    A mortgage is a loan used to purchase property. Note that the loan is secured against your property's value until you have finished paying it off, which means that you may lose it if you are unable to keep up with the repayments.

Other forms of credit

Sometimes it isn't always obvious that you are making a purchase on credit. For example, you may be offered the option of deferring the payment of an item (for example, a new sofa) for a few months, or paying for a higher value item, such as a new television, in a number of separate instalments.

Make certain that you can keep to the terms and conditions of the offer, and read the small print carefully. If you cannot make payment in full by the due date, under the terms of the offer, you may then be charged interest at a much higher rate than if you had purchased the item using a different type of credit.

Getting behind with payments

Before applying for credit, it's really important to make sure you can afford to keep up with your repayments comfortably. If you miss one or more repayments:

  • It could have a negative impact on your credit score or rating

  • You may find it more difficult to secure credit in future

  • You may incur penalties, and other conditions of your credit may be revised (like increasing the interest you pay on the balance outstanding)

  • You may find it harder to make ends meet, leading to further debt

  • Your property may be repossessed to repay the debt

  • You may have a court order awarded against you for the outstanding amount, plus interest and legal fees

  • Your creditor may start bankruptcy proceedings against you

If you find yourself in a situation when you cannot meet your repayments, you should consider:

  • Talking to your bank or credit provider. They may be able to help, for example by reducing your monthly payments by extending the term of your loan

  • Contacting a charity that specialises in debt and money problems. In certain cases they may be able to discuss your situation with your loan provider on your behalf

  • Getting advice from a qualified financial consultant or advisor

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