Credit is money that you borrow and pay back over time. Whenever you buy a product or receive a service without paying cash for it upfront, you're probably using credit. An accepted part of modern life, credit can be used to buy anything from a pair of killer Nine-West heels to mobile phones, your child's school fees or even a holiday. Without access to credit most South Africans could not afford larger purchases such as a car or a house.
How does it work?
To access credit, you can apply for a personal loan from a registered credit provider such as a bank. For a store card, you apply at a retail outlet; and for a credit card, at a bank, medical aid company, cellphone provider or even an airline. But before you can start, the credit provider will need to check your credit record and approve your application based on an affordability calculation.
Your credit profile is compiled by a credit reporting agency or credit bureau and includes personal information such as employment history, and financial details relating to your previous credit applications which include your ability and willingness to pay back the amounts owed on time.
If the credit provider is satisfied that you can afford the debt then you'll enter into a contract. How you spend the money is up to you but don't let the flash of a credit card lull you into a false sense of security. At some point you'll need to pay the amount back, plus interest! So, be sure you read the fine print. This would include how much time you have before the credit provider expects payment and how much interest you'll be charged on the original amount and on the amount still owing.
Credit - the pros
If managed responsibly, credit can help you buy products you need, and want, before you actually have the money. A good credit record will also give you access to more money - subject to the affordability calculation as per the National Credit Act - which could be used to make significant improvements to your life, such as a home loan.
Credit - the cons
Unfortunately, the lure of the good life and the convenience of a credit card can often influence one's judgement and the danger is that you can end up spending more than you have. This debt combined with the interest charged on the amount owing, means that you often pay far more for items than they originally cost.
Defaulting on a loan, making late payments, consistently exceeding your authorised credit card limit or declaring bankruptcy also negatively impacts your future credit potential. This means that even if you manage to pay off your debt, bad credit or poor past performance will reflect on your record for up to ten years - hampering your chance of qualifying for more credit when you really need it.
How to use credit responsibly?
Start small. If you're failing to meet your credit repayments, stop using your card. If you are not already using a monthly budget, then now's the time to start. A budget will help ensure that you meet all your financial obligations such as credit repayments. If you can't cope or need help, you must contact your creditors and discuss your situation. Most will be willing to set up a new payment schedule. Pretending to ignore the problem will only compound your headaches. Enjoy the credit, but ensure that you pay your bills on time.
Tips for building and protecting a good credit rating
• It's all about control. Borrow only what you can afford! Never let your monthly debt repayments exceed ten percent of your monthly net income (the amount before subtracting tax) and never spend more than 20 percent of your annual after-tax income.
• Always pay your bills, or at least the minimum amount, on time.
• Only consider taking on more credit if you're earning more than you spend on a monthly basis.
• Keep your finance file up to date with copies of sales slips and payment history.
• If you end up borrowing more than you earn, see which expenses you can cut out.
• Close accounts you're not using. Lenders look at opened but unused accounts as an opportunity for you to go on a "spending spree".
• Don't max out all your cards at once.
• Don't use your credit card to buy small items such as bread and milk or to draw cash.
This article was first released by Capitec Bank.