What is credit?
Credit is a sum of money made available for you to use, which you have to pay back plus some extra (interest/charges for the privilege!). See, it sounds simple when it’s put like that. But, the slightly trickier bit is choosing the right one for you! There are lots of different forms and types of credit, so make sure you do your research and decide which is the right option for you. You’ll need to consider things like the terms of a loan or credit card and interest or APR that you repay.
Why might I need credit?
If you want to buy something now and don’t have the money available, at that time. Also if the cost of the product or service is so expensive that you would be unable to pay for it all at once.
What types of credit are there?
- Personal loan – the provider gives you a lump sum of money which you pay back on a monthly/weekly basis. Interest is added so that you pay back more than you borrowed.
Sometimes you can spend the money on what you want, at other times the lender will specify what it is to be spent on as part of the loan agreement.
- Secured loan – similar to the above, but to buy high cost items such as a house. The loan is secured against the item bought, if you don’t keep up with the repayments the lender can force you to sell the item and repay the loan in full.
This is the only way most of us can hope to buy our own home. Interest rates are far lower than personal loans as the lender has a way of getting their money back if you don’t pay.
- Credit cards – you have a card and a maximum amount you can spend on the card. You use the card to buy things and then receive a bill once a month. If you pay the bill in full you won’t pay any interest. Otherwise the bill tells you the minimum amount you must pay – this covers the interest plus a small amount of your spending. As long as you don’t go over the maximum spending limit and pay at least the minimum amount each month you can carry on using the card. It is easy to get carried away with a credit card – remember you are going to have to pay the bill sooner or later Only paying the minimum amount every month means that it could take you a long time to pay back the money borrowed and you will inevitably pay much more interest.
Storecards – very similar to credit cards, but limited to use in a particular shop or chain of shops. The interest rates tend to be higher than credit cards.
It can be tempting to take these out if you are offered some form of freebie or a percentage off your purchase – but it is another bill to remember to pay, and if you forget or only pay of part of the balance, the interest could be far more than the value of the purchase
- Charge cards – as the name implies a card that you charge purchases to. Unlike credit cards, the balance has to be paid in full when the bill arrives at the end of the month. So you are only offered credit for a very short period of time.
There is often a monthly fee for the privilege of having the card and they are generally only available to people with a good monthly income and credit history.
- Hire Purchase/Conditional Sale/Rent to Buy – there are slight differences between these three, but the basic premise is that you have use of an item but don’t own it until you have fully paid for it (so if you don’t meet the repayments, the seller can take their goods back). The money you pay to use the item contributes to the cost of owning it at a later date. After an agreed number of payments you either own the item outright or have the option to own it. Sometimes you have to make a lump sum payment at the start and/or the end of the agreement
The lender has different legal rights over the item according to how much of the total (including the cost of borrowing) amount you have paid. If you miss payments make sure that you get some expert advice as to your rights.
- Leasing – you obtain use of an item for a regular payment, but you don’t own it and hand it back at the end of the lease period. It is similar to renting a house, but on a higher wear and tear item such as a car. Some lease agreements have an option to purchase clause, which means that you can pay further money at the end of the agreement to buy the item outright.
The difference between leasing and HP is the intention at the start of the agreement – HP is designed for purchase, leasing for renting but sometimes with the option to change your mind at the end.
- Doorstep loan – this is a type of personal loan which is obtained from an agent who calls at your home. The same agent will also collect your repayments, often on a weekly basis. These loans might be given to consumers who would be turned down by high-street banks due to poor credit histories.
The cost of these loans tends to be quite high due to the services of the agent.
- PayDay loan – A sum of money lent to you until your next pay day. They are intended to be short term loans to cover unexpected costs that you may incur. Relatively small amounts are lent and the money is usually made available very quickly.
These loans are expensive and are intended for very occasional use only in emergencies. Pawnbroking – to use this form of credit you need to have an item of value (often jewellery). The pawnbroker lends you a percentage of the value of the item and then holds the item in secure storage. You have a fixed amount of time to repay the amount borrowed plus interest (usually the maximum is around six months) in order to get your item back. If you fail to do this the pawnbroker has the right to sell your item.
If you need cash in a hurry, have and are willing to risk an item of value, this could be a cheaper way of borrowing than a PayDay loan.
- Credit Unions – not a product, but a not-for-profit financial institution set up by members with something in common to benefit their community,. Credit Unions offer similar financial products and services to banks and building societies, including providing loans for smaller amounts at reasonable rates.
Loans from credit unions are generally cheaper than loans from most other providers for smaller amounts and do not incur set-up fees, administration costs or early redemption fees. If you have one near you, and/or you are eligible for membership of one, it is normally a very good place to start looking for smaller or shorter term credit.
What should I think about before buying?
APR is probably a phrase you constantly hear referred to on adverts and in the press, but surprisingly few people actually understand the meaning of it. With any kind of credit, you are likely to be charged interest – and a good way of comparing that interest rate is the APR or Annual Percentage Rate.
The boring bit…the way APR is calculated is pretty complex. However, it is important to look at this figure because the higher the APR; the more interest you will be paying, which is never a good thing!
One word of warning though – the A in APR stands for Annual, which means that if you are intending on taking out credit for a year or more it should give you a good comparator. But if you are looking for shorter term credit over 30 days say, the APR might not be so useful, as the figure still relates to what interest you would pay if you borrowed it for a year. In these cases, it is essential to know the pounds and pence amount of interest as well as the APR, so that you are sure you can understand and compare properly.