Understanding Credit

Credit has become part of the way the world works - understanding credit will help you understand your finances.

These days, credit has become part of the way that the world works. To buy a plane ticket, do online shopping, or make a big purchase without some kind of credit facility is next to impossible. But how does it work?

Credit works on a foundation of three elements: Risk, Time, and Cost. Because there is always a risk when someone borrows money from a credit provider, it usually needs to be paid back over a specific time period at a cost (interest, service fees, opening costs). So, it is important to remember that it costs money to get money.

Three Types of Credit

  1. Credit Facilities (revolving credit): You are given a maximum amount of money that you can use and each month you make a payment on that facility. Examples of this are store cards or credit cards at banks.
  2. Credit Transactions/Instalment Credit: A creditor loans you a specific amount of money, and you agree to pay that money and interest back in regular instalments of a set amount over a fixed period of time. For example, mortgage or personal loan payments.
  3. Credit Guarantee: This is when someone else promises to fulfil any payments that are made on behalf of the person who is using the credit facility or performing the credit transaction. We also call this signing surety in South Africa. For example, if a young person would like to take out a student loan, one of their parents usually signs surety for them so that they can get the credit facility.

The important thing to remember when looking at taking out credit is whether you can afford to borrow the money and whether it is really necessary to create that debt. Unless you’re a responsible borrower and understand your financial limits, it is not a good idea to create debt through getting credit for:

  • Paying off another credit facility
  • Making ends meet
  • Trying to look a certain way to others
  • Unnecessary and luxury items

Before you decide to borrow, you need to have a very clear picture in your head of why you are borrowing, and realistically whether you can pay it back. That will help you to make the right decision in terms of the kind of credit facility you should be using and will keep you financially healthy.

If you’d like to see a list of all your credit accounts, go to www.mycreditcheck.co.za to view your complete credit report including credit history, payments, account types, and more.

Get your free credit report!