What credit is and how it works for you

What is Credit?

 

Simply put - credit is the approval to pay later for purchased good and services. Once you choose to pay by credit, you accumulate a debt with the entity which lent you the money.

 

How does Credit work?

 

When using credit, you enter into an agreement with the lender. You must payback the amount borrowed with interest at a nominated rate. You don’t have to pay the full amount back because the institution is making more money from you every month. You must pay what’s called a Minimum Repayment Amount. This is usually a percentage of your balance more information about this and other terms can be found here.

 

If you are not careful, your debt can quickly spiral out of control click here to find out about debt and how to stay out of it.

 

Say you get sick or injured and cannot work? It would then be very hard to keep up the monthly repayments on the amount you owe.

 

What types of Credit are there?

 

There are two forms of credit a lender can give you. These are Secured and Unsecured.

 

• Secured credit is approved to someone if they can provide a form of collateral or asset such as a house or car to secure the repayments. If the borrower cannot meet his or her monthly obligations, the lender can then sell the asset to recover the debt. A secured loan usually has a lower interest rate simply because the bank has the security of your asset should everything go bad.
  

• Unsecured credit does not have any collateral associated with it. Credit cards are typically unsecured credit. Higher interest rates apply to unsecured credit as a method of ‘securing’ the loan from the bank. They can’t take your house or car, but they can make you pay more interest every month.

 

How does interest work?

 

Every time you make a purchase on your credit card, it attracts interest. If you have interest-free days on your card, the lender will start calculating interest after this period. This is not as it seems however and more information can be found here.

 

Let's say Jan wishes to buy a hair straightener for $400.00. She doesn't have the cash to pay for it, so she borrows credit from her bank in the form of her credit card. There are no interest free days on her card, so she's paying interest right away.

 

 

Item	Cost of item	Interest Rate	Interest Free days	Interest Payable	Total Cost
Hair straightener	$400.00	16.25%	None	$65.00	$465.00

 

 

Interest can either be fixed or variable and the rates differ accordingly. And the rate can also vary depending on whether you have interest free days or not. The latter means interest is calculated from the day you purchase your items. The rate is usually lower than a card with interest free days.