Distinguishing between types of credit
Many consumers assume that all credit is created equally, thus causing them to run into debt problems.
Different types of credit/debt:
With secured credit, the creditor guarantees that the credit will be paid back by placing a lien on an asset the client owns. The lien entitles the creditor to take the asset if the client defaults on the credit agreement. Car loans, mortgages, and home equity loans are common types of secured credit.
When credit is unsecured, clients simply give their word to the creditor, that they will repay the borrowed amount. Unsecured credit is not backed by financial security or collateral. Card, medical, and utilities bills are all examples of unsecured credit.
With instalment credit, a certain amount of money is borrowed for a set period of time and repaid by making a series of fixed or instalment payments. Examples of instalment credit include mortgages, car loans, and student loans.
Seeing yourself through a creditors’ eyes
To be a savvy consumer, it is important to know the criteria that creditors use to evaluate the client when applying for new or additional credit. Factors taken into account include:
- Character: Does the client’s credit history show that they’ve got a history of repaying debts? Is the client up to date with repayments? No arrears, no short payments or late payments?
- Financial capacity: Can the client afford to repay the money that they want to borrow? Under the National Credit Act (NCA) lenders now have to do a full ‘affordability test’ to see whether individuals can afford to borrow the funds they are applying for.
- Collateral: if the client has a poor credit history, or if the client is asking to borrow a lot of money, creditors want to know whether the client has assets to secure their debt or guarantee payment.
These criteria not only determine whether a creditor will approve or deny credit; they also impact how much credit is given, the interest rate and what other terms of credit apply.