Credit means borrowing money and paying it back, often over time, and usually with interest added. Throughout your life, there may be times when paying for things with credit would be helpful, and others where it would be challenging to pay by any other means.
For example:
- It might be helpful to borrow the money to pay for a car repair, and then pay back the money in instalments.
- For most people, a mortgage represents the only realistic way of buying their own home.
As a general rule, try to avoid using credit to cover your everyday expenses where possible.
Applying for Credit
When you want to borrow money, you can apply to your bank or another lender. All financial institutions have a duty to lend responsibly, and so whether or not they lend to you, and the interest rate and terms they offer, may depend on a number of factors:
- Your reason for borrowing
- The amount you need to borrow
- How much can you afford to repay each month
- The length of time you need to borrow for
- Your employment status
- Your personal circumstances
Your Credit History
Your ability to obtain credit, and on favourable terms, will also depend on your history of borrowing and paying back money in the past. Lenders refer to this as your credit history, which is sometimes expressed as your credit score. They want to assess how reliable you are at borrowing money and then paying it back.
You can usually find out your credit score and check that your credit history is being reported accurately, often without charge. There are several benefits of doing this on a regular basis:
- Your credit score will give you an indication of whether or not you will be able to secure credit readily.
- 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 recognize, it could be an indication that you are a victim of identity theft or fraud.
| Your credit rating is scored on several factors, including: | |
| Positive reporting | Your history of paying back credit consistently and on timeYour levels of unused creditThe infrequency of your applications for credit |
| Negative reporting | The number and frequency of late credit card and other credit repaymentsThe amount (%) of credit in useThe frequency of your applications for credit |
How to improve your credit score
If you need to improve your credit score, here are five steps you can take:
- Check your credit score/report regularly for mistakes, and report anything that you think is wrong or looks suspicious, right away.
- Make repayments on time, including credit card and debt payments, as well as regular payments like your mobile phone bill.
- Stay within your credit limits, and try to keep your credit utilisation (in other words, the amount of your available credit you are actually using) as low as possible.
- 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.
- 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 the short, medium or long term.
- Short-term debt
Examples might include needing to cover your costs until you get paid next, or having to find the money for a boiler repair or other unforeseen expense. For such examples, the following types of credit are typically used:
- Arranged overdrafts
Arranged overdrafts let you continue spending money from your bank account when there is no money left in it. You will agree on an arranged overdraft limit with your provider, which is the maximum amount that can be borrowed. You will usually pay interest on your overdraft, although sometimes you will have an initial, interest-free overdraft limit
- Credit cards
Credit cards enable you to buy or pay for things now and then repay them at a later date. If you owe money, you have to make at least 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, typically you’ll 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 may help you spread the cost of regular or one-off purchases. If you don’t have an emergency fund, credit cards can also provide back-up to cover unexpected costs.
Remember that the amount you owe – money you’ve spent on the card, plus interest – can add up if you’re not careful. Try to pay back as much as you can each month. The more you pay back, the less interest you’ll be charged
- Personal loans
Personal loans provide quick access to funds that can be used for just about any purpose. With a fixed rate, consistent monthly payment amount, and a set pay-off date, you’ll be prepared for whatever comes your way.
- Medium-Term Debt
Examples might include buying a car, paying for a vacation or for home improvements, where it might be helpful to be able to spread the cost of a purchase. For examples like these, the following types of credit are typically used
- Bank or Other Loans
A loan is where you borrow a set amount of money for an agreed-upon amount of time. You pay back the full amount – usually in monthly instalments – plus interest.
Note that spreading your payments over a longer period means you may end up paying more overall
- 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
Examples might include the cost of building or purchasing a home. For substantial, long-term debts like this, a mortgage is the most commonly used type of credit
- Mortgage
A mortgage is a loan used to purchase property. Note that the loan is secured against your home’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.
- Falling Behind On 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 outstanding balance).
- 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 issued 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 where 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.
- Getting advice from a qualified financial consultant or advisor.