Crash course in credit

Hello Folks,

We are now on the third and final post on the basics of finance.

In this post, we will look at credit and the types of credit.

First, we will find out what credit is, then, I will introduce you to the credit score and the report and finally, we will look at different types of credit. 

So, let’s start 

Credit 

Credit usually refers to the ability to borrow money, with the understanding that We’ll pay later. Generally, credit comes with interest added on top. Interest is a charge we pay for the pleasure of borrowing the money now instead of saving for it ourselves.

Credit score 

A credit score is a number that indicates how well we have dealt with credit in the past. The higher the score, the more likely you are to get credit and pay a lower rate of interest. In contrast, the lower the score the less likely you are to obtain credit and if you do secure credit, you will pay a higher rate of interest.

Five components make up your credit score. The first and most important is your payment history. Next, is the amount of debt you owe. Your payment history and debt make up 66% of your credit score. The length of your credit history, how many different types of credit you have ( e.g. credit card, car loan, mortgage) and the number of times a lender has recently checked your score for credit, make up the other 33% of your score.

Credit report

Your credit report gives the details of the credit you have taken out in the past. This will include credit cards you’ve owned, the balance and whether you make payments on time.

You can check your credit file by accessing your report from Experian, Equifax or Transunion. You may want to check all three to get a clearer picture of your credit file.

Credit cards

Credit cards are issued by the bank and the bank makes money from charging you interest on the outstanding balance of your debt. A credit card is essentially a loan from the bank that you need to pay back. You pay interest (money on top of the amount you borrowed for the pleasure of borrowing the money), there are also other fees such as late payment charges.

Some credit cards offer rewards such as points at the end of the year which you can use to pay towards gift cards, hotels or air miles.

Pro- Helps to establish a credit history 

Pro- Rewards

Pro- Free loan, if you pay your card off in full every month

Con- You can easily fall into debt 

Con- You pay interest on the money you borrow

Debit cards

Debit cards draw money immediately from your current account. Therefore, unlike credit cards, you can’t spend more than you have (unless you have an overdraft).

Pro – You can only spend the money you have in your current account (unless you have an overdraft)

Con – You may need to pay a monthly fee for extras on the account 

Con – Does not give you a free loan 

Mortgage 

A mortgage is a fixed-term loan that you use to buy a property. To get a mortgage you will need a cash deposit of at least 5% and like other loans, you will pay interest on the amount you borrow. Generally, you pay back the loan in monthly instalments over a set number of years. 

There are 3 basic mortgage types 

Conventional/ Fixed Rate Mortgage

Conventional fixed-rate mortgages have consistent payments. If you have a conventional mortgage your monthly payments won’t change over the life of the mortgage. The fixed-rate mortgage generally has a fixed term of between 10 -40 years depending on your age and other factors.

Interest-Only Mortgage 

An interest-only mortgage gives you the option to pay only the interest portion of your mortgage. You will not own the property if you chose an interest-only mortgage. You are paying off the interest and nothing towards the mortgage.

Adjustable-Rate Mortgage

The adjustable-rate mortgage has an interest rate that fluctuates over the lifetime of the mortgage. The interest rate changes with changes in the economy. Therefore, payments can rise or fall just like the bank of England interest rates.

Car loans

After student loans and mortgages, the next largest source of household debt is a car loan.

There are 2 basic types of car loans, a standard loan or you could lease the car. 

Standard car loan 

If you choose to take out a standard loan to pay for the car you will pay back the initial cost for the car and then interest will be added on top. Again, you pay interest here for the privilege of borrowing the money and buying the car before you have saved up enough money to buy it. 

Pro- You own the car once the loan is paid 

Con – You have more expensive monthly payments

Car leasing 

The second way to finance a car is through leasing. When you lease the car you don’t own the car, you will make lower payments as the car payments will cover the drop in value of the car over time. You will need to return the car after the lease period ends.

Pro- Cheaper monthly payments

Con – You do not own the car once the lease ends

Con- You must keep the mileage within a certain limit 

Con- You are paying for the most expensive years of ownership 

And there we have it guys,

We have come to the end of our whistle-stop tour of the basics of finance

Although it’s a rather dry topic I hope you found it a useful basis to begin your financial awareness journey.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: