Credit

A credit is a more flexible form of finance that allows you to access the amount of money loaned according to your needs at any given time. The credit sets a maximum limit of money that a customer can use in part or whole. The customer may use the available cash either fully or partially. A customer may also decide not to use it at all.

The usual ways to obtain finance through credit are credit cards and credit facilities or lines of credit generally arranged through a current account in which deposits and withdrawals could be made up to the agreed limit.

Credits are usually used to cover delays between receipts and payments for companies, to deal with specific periods of lack of liquidity, or for particular purchases. On the other hand, loans are often used to finance the purchase of goods or services.

Credit is a powerful tool in achieving your financial goals. With the help of credit, you can build a large amount of wealth over time with minimal risk.

Types of Credit: Unsecured and Secured

Unsecured credit is also known as credit card debt or revolving debt. This type of credit is not backed by collateral, such as a car or home, and is usually used for small purchases, such as groceries or gas.

Secured credit is known as secured loans or installment loans, and it requires the borrower to put up some form of collateral, such as a car or home.

The main characteristics of a credit that distinguish it from a loan are:

• Interest on credit is usually higher than on loan.
• Interest is only paid on the amount used, although there may be a minimum fee on the undrawn balance.
• As the money is returned, more would become available, provided the limit is not exceeded.
• Unlike the loan, the credit is usually renewed each year to allow the customer to continue to use this credit facility whenever necessary.

Understanding Your Credit Options

When it comes to borrowing money, you might wonder what your options are. This section will help you understand your credit options and the risks involved.

Credit Score

The first thing that you need to do is determine your credit score. Your credit score is a numerical representation of the collection of data about your borrowing, payment, and debt history. The credit score is the most widely used scoring model for this purpose. Your credit score will determine your eligibility for obtaining credit and its terms, like interest rate, duration, collateral, etc.

• A credit score of 750+ or above means that you are considered an excellent borrower with a low risk of defaulting on loans and a high chance of getting approved for them.
• A score between 600-700 is the average score, and it’s likely that you may qualify for a credit, however, with some restrictions or limitations.
• The credit score ranges from 300-600 could be viewed as a risk level. As a result, financial institutions may not prefer giving credit or loans.

It is not just about how much you owe but also your behavior and payment history. The higher your credit score, the lower your risk of defaulting on loan payments or not paying back loans on time.

Credit Options

Credit options will vary depending on your financial situation. Credit is a loan that allows you to purchase goods or services now and pay for them later with interest.

The three main types of credit are:

• Unsecured loans: Credit cards, personal loans, payday loans.
• Secured loans: Home mortgage, car loan, student loan.
• Mortgage credit: Home mortgage.

What are the Good Uses of Credit?

Credit can be used in very positive ways to enhance personal financial planning. Following are some of the reasons people use credit:

• For Convenience: Using credit cards simplifies the process of making any purchases. It provides a record of purchases and can be used as leverage if disputes arise later. As a result, the convenient use of credit is growing. For example, many of us now use credit cards at the grocery store and the gas station. However, convenience use is justified only if the card balance is paid in full each month. You do not want to be paying for today’s restaurant meal for months or years in the future.
• For emergencies. Consumers may use credit to pay for unexpected expenses such as emergency medical services or automobile repairs.
• To own expensive products sooner. Buying “big ticket” items such as a home or automobile on credit allow the consumer to enjoy immediate use of the product. Many expensive items would not be purchased (or would be bought only after several years of saving) without the opportunity to pay for them over time. The product’s expected life should be at least as long as the repayment period on the debt.
• To take advantage of free credit. Merchants sometimes offer “free” credit for some time as an inducement to buy. Free credit, however, should not be used to buy a more expensive item than you can afford. Known as “same as cash” plans, these programs allow buyers to pay later without incurring finance charges. The free credit lasts for a defined period, but interest may be owed for the entire period if the buyer pays even one day after the allotted free-credit period ends.
• To obtain an education. The high cost of education has forced many students to use student loans. This may be one of the better uses of credit, as the borrower is investing in themself to raise their quality of life and income in the future.
• To make reservations. Most motels, hotels, and car rental agencies require some form of a deposit to hold a reservation. A credit card number can serve as such a deposit, allowing guaranteed reservations to be made over the telephone. In many cases, the hotel will notify the credit card issuer to put a hold on your account for the anticipated total amount of the charge. This common practice is called credit card blocking.

What are the Downsides of Credit?

Despite its benefits, the use of credit has a downside. Negative aspects include interest costs, the potential for overspending, credit’s negative effect on your financial flexibility, and privacy concerns.

Use of Credit Reduces Financial Flexibility: The most significant disadvantage of credit use comes from the loss of financial flexibility in personal money management. As the old German proverb states, “He who borrows sells his freedom.” The money that you pay each month on your debts is money you could have spent elsewhere on other opportunities. Credit use also reduces your future buying power, as the money you pay out on loan includes a finance charge and the principal. Credit can be seen as a promise for you to “work for the creditor” in the future to pay off your debt.

It Is Very Tempting to Spend More Money: A significant disadvantage of credit is its use can lead to overspending. For example, using a credit card to buy Rs 10,000 worth of new clothes and paying Rs 500 per month for 36 months (a total of Rs 18,000: Rs 10,000 for the cost of clothes and Rs 6,000 for interest charge) may seem less painful than paying cash for a planned purchase of only Rs 10,000 worth of clothes. The problem is this: Once you begin carrying credit card debt, it may seem more straightforward to buy more on credit, especially if you have more than three or four cards—as is typical for Indian credit card holders.

Debt Reduces Your Ability to Save and Invest: Saving and investing over long periods is the key to building wealth. However, taking on excessive debts early in life will seriously compromise your financial success goal.

Know What Could be the Cost of Credit

Despite its benefits, the use of credit has a downside. Negative aspects include interest costs, the potential for overspending, credit’s negative effect on your financial flexibility, and privacy concerns.

Use of Credit Reduces Financial Flexibility: The most significant disadvantage of credit use comes from the loss of financial flexibility in personal money management. As the old German proverb states, “He who borrows sells his freedom.” The money that you pay each month on your debts is money you could have spent elsewhere on other opportunities. Credit use also reduces your future buying power, as the money you pay out on loan includes a finance charge and the principal. Credit can be seen as a promise for you to “work for the creditor” in the future to pay off your debt.

It Is Very Tempting to Spend More Money: A significant disadvantage of credit is its use can lead to overspending. For example, using a credit card to buy Rs 10,000 worth of new clothes and paying Rs 500 per month for 36 months (a total of Rs 18,000: Rs 10,000 for the cost of clothes and Rs 6,000 for interest charge) may seem less painful than paying cash for a planned purchase of only Rs 10,000 worth of clothes. The problem is this: Once you begin carrying credit card debt, it may seem more straightforward to buy more on credit, especially if you have more than three or four cards—as is typical for Indian credit card holders.

Debt Reduces Your Ability to Save and Invest: Saving and investing over long periods is the key to building wealth. However, taking on excessive debts early in life will seriously compromise your financial success goal.

Conclusion: Know Which Type of Credit Is Best for You

The most popular type of credit is the credit card. Credit cards are convenient and easy to use but have many limitations. For example, the interest rates can be high, and the debt you accrue will be challenging to pay off if you mismanage your finances.

However, other types of credits can help you manage your money more effectively, such as personal loans or home loans. These credits offer a lower interest rate and a more extended repayment period so that you can avoid accumulating too much debt at once.