Credit has been given a bad name, only being associated with debt and bad credit history. However, credit can have an advantageous impact on your finances and life as well. Here’s how. When credit in its varying forms is used correctly and responsibly, the reward of having it is worth the risk. The most important thing to remember is to stick to a dedicated plan and budget so your credit isn’t misused.
Are credit cards “good”?
Credit cards can carry a very bad reputation. This is because the negative results of using a credit card irresponsibly are always front and centre. But they can be good and a great financial tool if used right. All credit can be considered good if you keep up with monthly repayments and supplement your financial life in positive ways with credit. Credit can help us reach milestones such as, paying for a child’s education or wedding or putting capital back into your business.
What are the C's of credit?
When you apply for credit in terms of a new loan or a credit account, financial institutions and lenders conduct a credit analysis on borrowers to assess the risk that they could take on if they issue credit. The process is based on the analysis of 5 important factors that can predict the chance that borrowers will fail on repaying a loan back. These 5 C’s are;
Lenders place most of the wait on this C to determine your credit credibility. Capacity is your ability to repay a loan based on its proposed terms in consideration with the income you earn and how stable your employment is. Other debt responsibilities and repayments are also taken into account as it influences the total amount of income you receive each month. Lenders measure this through your debt-to-income ratio, which shows your monthly debt as a percentage of your monthly income. A higher ratio means a higher risk for the lender.
As above, your income plays a crucial role in credit analysis. However capital also consists of your savings, investments, and other assets that can be used to repay a loan. If you are considered a borrower with a substantial amount of capital, lenders will more likely issue credit as it means that you are most likely not going to default on the loan because you could stand to lose your assets.
Conditions mean a few different things. Lenders take into account economic conditions that can affect your ability to repay as well as the overall purpose of the loan. This means that the reason why you are needing a loan can affect whether you will be issued credit or not. For example, needing capital for business, home renovations or debt consolidations are popular reasons. Taking out a loan for cosmetic reasons or unnecessary purchases can affect a lender’s decision and the conditions to which the loan is issued.
Your character in the credit analysis process refers to your previous history and reputation with credit, in both qualitative and quantitative manners. Lenders use this to determine what your future behaviour could be. Qualitatively, lenders assess your educational background, employment history, and having an interview with you. Quantitatively, and objectively the most important way, a credit check is conducted on your financial track record to determine if you have made payments on loans before and your overall credit score.
All loans and credit cards are either secured or unsecured. Secured loans are backed against your personal assets like a car, a home, or a deposit. These are known as collateral. Secured loans can be considered easy to apply for as lenders can take possession of the collateral if the loan defaults.
What are the advantages of using credit?
A few advantages of having a credit card and credit are;
- Convenience: Keep cash on hand and make sure that you are spending within your limits.
- Recordkeeping: Credit cards can function as a record of your spending and can help with budgeting efforts.
- Low-cost loans: Easily pay for larger purchases, as long as you pay it off at the end of the month.
- Cash advances: Have access to money when you need to, giving you increased purchasing power.
- Member perks: Some credit cards come with rewards such as discounts or cash-back perks.
- Build good credit history: You can build a good credit score for future credit applications by staying on time with your payments when making purchases.
- Purchase protection: Credit card purchases are protected in case you need to return a defective product or file a complaint.
Tips to Use Credit Responsibly
The first and most important tip to remember when using credit is to pay your monthly repayments on time, every month and never late. This is the ultimate way to build a good credit score and avoid late penalty fees. Set up a payment schedule to keep track of upcoming payments.
Have a line of credit open for a long period of time as it can positively impact your credit score as well. And beyond your payments, try paying off the balance of credit during its lifespan. This will help keep your debt-to-income ratio below 10% which is considered best practice and also keep you from paying interest.
Use the rewards that come along with your credit card. It will help you save where you can in the form of cash-back or redeem other perks. Along with this benefit, credit cards can also include purchase protection, free credit score assessments, product insurance, etc. Make full use of your credit card and understand what benefits are available to you.
Credit can certainly have a good impact on your life, after all it’s a financial support system that is only beneficial to us if we use it responsibly and thoughtfully. Here’s how to take control of your credit spending.