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Credit can be confusing, what is credit and how might it help you manage your money?

Credits can be confusing

Credit can be confusing! Buying something on credit or applying for credit is a form of debt, and will need to be repaid. But before we get to that,what is credit and how might it help you manage your money? We’ve run through everything you need to know about credit, and talked to some people who have had experience with credit – good and bad.

 

Types of credit:

  • Credit or Store Cards:  To help you pay for goods and services.
  • Personal loan: Anything from a small amount to help out with everyday items, or large loans for things like cars.
  • Interest-free credit: Borrowed money that doesn’t gain interest. So you only pay back the money you borrowed.

How interest works

When you borrow money from an organisation, they usually add interest – which is the price you pay for borrowing from that particular lender. You might see this referred to as the Annual Percentage Rate, or APR.  When you borrow money, you should agree to the amount of interest you are going to pay on top of your loan.

Here’s an example of how it works: You buy a £100 TV on credit, and you borrow money with an APR rate of 20%. If you spread your repayments over a year, you will end up paying £120 back for the TV in total.

Pros and Cons of Credit

Pros:

  • You don’t have to pay it back all in one go – credit is usually paid back in monthly amounts called instalments, which means you can spread repayment out over a few months, as opposed to one big chunk.
  • Good in emergencies – if you need money quickly, for example, if your boiler breaks down, you can use credit to pay for repairs if you don’t have the cash to hand.
  • Interest-free credit – this means you only pay back what you borrowed, rather than that figure plus interest on top. However, this is normally for a limited period of time, after which interest rates will kick in. If you choose this type of credit, check when you will have to start paying interest. All this should be listed in the terms and conditions of the loan, as well as lots of other important information about the loan, and if you ask, the loan supplier should be happy to explain all of these to you.

Cons:

  • Temptation – It’s easy to spend money on credit, because you don’t have to pay it back immediately. However, you can quickly find yourself with a big debt you can’t afford to pay back.
  • Interest – Buying on credit – unless covered by interest free credit – means you’ll have to pay an additional charge on top of the value of the goods you bought. For example, buying a £100 microwave on credit which charges 20% for one year means you’ll end up paying £120 in total over the course of that year.
  • Fines – if you’re late repaying credit, you could receive a fine, which will affect your credit rating (see below).

Credit Rating

A credit rating is a score banks and lenders use to work out if you can afford to pay back the money you borrow.

It is put together by agencies such as Experian, Equifax, or Callcredit who will look at things such as:

  • How well you have paid back other loans or whether you pay your bills on time.
  • How much money if coming into your account (your income).
  • How much you’re spending and what you’re spending it on (your outgoing or expenditure).
  • Big things you own, such as a house.
  • Any other loans or credit you have at the moment.
  • If you have borrowed money in the past and not paid it back or you have been turned down for a loan.

If you do want to apply to borrow some money, a credit report can help show you how likely you are to be successful.

The Money Advice Service  has lots more information about credit rating and credit reports.

How to improve your credit rating

Here are a few tips for improving your credit rating.

  • Make sure you’re on the electoral roll – this will help lenders make sure you are who you say you are.
  • Cancel any credit cards you don’t use, as they can count against you applying for new credit.
  • Having a landline rather than mobile number on an application form can help improve your chances.
  • Pay bills on time – lenders can see if you’ve made late payments on existing or previous debts, which may make you less eligible for being accepted for credit.

Katrina, 21, talked to us about credit:

A little while after getting my first credit card my limit got increased to £1,000, which I thought was great. But the temptation to spend was too much and I ended up maxing it out – I even went over the limit. I started making the minimum payments of around £25 a month but they were barely making a dent, purely paying off the charges. I work full-time now and I have managed to pay most of it off, but when I knew I was in that much debt, it was a huge burden and financial pressure to me. Talking to the company about a payment plan and building bigger repayments into my budget was the only way I could get back on track. My credit cards are now cut up and in the bin. But if you do get a credit card, I would say ALWAYS think sensibly before spending money that isn’t yours. Can you pay it back next month? Do you really need the item that urgently? A credit limit isn’t a spending goal.

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