Using credit and going into debt can be risky. If you don’t know what you are doing you may end up in a lot more debt than you planned. It could also affect your credit rating. A credit rating is a record of your credit applications and any repayments you may have missed. A bad credit rating could make it harder for you to borrow money in the future.
Let’s say you’re planning a holiday. You’ve told one of your older friends all about it. You want to ask her advice about how to get the money you need for the holiday.
Sure I’ve borrowed money before. What do you want to know?
Credit is borrowed money that you pay back with extra costs such as interest, fees and charges. You will be asked to sign a credit contract which is a legal agreement. The contract outlines the amount of money you have to pay back to the financial institution and the time period you have to pay it back by.
It’s really important to understand that credit is borrowed money and needs to be paid back to the lender. Not only that, accessing credit comes at a price. You will have to pay back the principal plus interest as well as fees and charges. And if you don’t pay on time, it can quickly add up.
You can learn more about credit contracts by visiting the moneysmart.gov.au website.
Interest is extra money you pay for using credit and it can be fixed or variable. The fixed interest amount is set at the beginning and doesn’t change, so for example you might be charged 10% every month for the term of the credit contract for the money you have borrowed. But variable interest rates can change, so one month you might be charged 10% and the next it might be more or less than 10%.
With fixed interest, the repayments don’t change, but with variable interest, the repayments may increase or decrease.
First you need to work out exactly how much money you need to borrow, how much you can afford to pay back and what type of credit is best for you. Remember, you will have to pay back all the money you borrowed, plus interest. So try not to borrow more than you can afford to pay back as you may have legal problems by not paying what you owe. There may also be long term effects for you if you don't pay what you owe.
You might want to borrow $10,000. If you work out your monthly repayments, you may find you can’t afford to borrow that much. Once you have an idea of how much you can afford to borrow, then you can look for the type of credit that is best for you. Or maybe you'll decide you'd prefer to save the money and avoid paying interest altogether.
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What options are you looking at? Click an option below.
This is not a great option for a holiday. You should only really use a credit card for emergencies and you should try to pay it off in full each month. That way you are not charged any interest.
You see credit cards usually have high interest rates, anywhere from 10% to 20% or even higher. So if you just pay off the minimum each month you end up paying back a lot more than you borrowed. For example, with a credit card you might set the credit limit at $5,000 at 17% and end up paying back around $15,000 in just over 29 years – that's around $10,000 in interest. Also, if the interest rate is variable, the amount you have to pay back may increase if interest rates go up.
The best advice is to only use a credit card for emergencies. That’s real emergencies, not fashion emergencies! Try and pay off the credit card every month to avoid getting into that spiralling interest trap. And shop around to find funding that best suits your financial needs.
This might be the way to go for a holiday. Personal loans are specifically designed for things like small home renovations, cars and holidays.
The interest you are charged is a lot less than for credit cards, is usually fixed and you repay it back over a specified period of time. So with a personal loan, you might borrow $5,000 and end up paying back over $6,500 over a few years. This means the overall cost of borrowing may be a lot less than if you use a credit card and pay just the minimum off each month. Also, because the loan is fixed, you know exactly how much you have to pay off and for how long. This is handy in helping you work out if you can afford the loan.
You should also watch out for extra fees and charges for things like paying off the loan early or being late with a payment.
Remember, a loan is a contract between you and the lender. You may have legal problems if you don't pay back what you owe. A personal loan is a good option, but there are other options.
This is a tricky one. Borrowing the money from family or friends might be the cheapest way to go as they may not charge you any or as much interest. They may also choose to become a guarantor to allow you to get a personal loan, which means they legally agree to pay back the loan if you don’t.
But mixing finances with family or friends can be risky. What if they suddenly need the money back? What if your family has guaranteed your loan and you can’t pay it back? They might have to sell something that they own to pay back your loan.
Think about this option before you take it up.
Yes, it is not always the best option to borrow from family and friends. Think about this option before you take it up.
This is the best way for sure, even if you only save up some of the money. Because the less you borrow, the less you have to pay back and the less interest you'll pay.
I know what you’re thinking – I can’t save up that much. But you’d be surprised. Plan a budget, set a savings goal and stick to it like glue. Before you know it, you’ll be on holidays and better still, you might be debt free.
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If this happens, call the lender straight away and work out a payment plan. Then stick to it. If you ignore the problem, it will just get much worse and your credit history may be affected. A credit history is a record of your credit applications and any payments you've missed. A bad credit history can make it difficult to borrow money again and you may end up with legal problems by not paying what you owe.
If you find yourself in financial difficulty and can’t make loan repayments, make sure you call the lender immediately and explain your circumstances. Be diligent. There are long term consequences to your credit rating if you fail to meet your financial obligations. You can get help from a free financial counsellor if you have money problems.
A classic mistake people make when they have maxed out one card is to get another credit card and use it to pay off the first one. They think they are outsmarting the system, but all they are doing is getting themselves more and more into debt.
In a word, no. Credit cards have a set limit which is the maximum amount you set and the bank agrees to make available to you This limit can sometimes be increased if you request it and the bank agrees. But it is wise to keep your credit limit low for a number of reasons. You still need to pay back whatever money you use on your credit card at a high interest rate. If you're an impulsive spender it can prevent you splurging on things you can't afford. If you apply for a loan many lenders look at credit limits as debt because you can easily increase your debt by spending up to your credit limit. Smaller credit card limits reduces your risk of having large amounts of money stolen from your credit card account.
If you have a smaller limit on your card like a thousand dollars and your credit card details are stolen, the most you can lose is a thousand dollars. Also at this limit, the most debt you can incur is a thousand dollars - plus whatever interest you will be charged.
Credit is borrowed money that you have to pay back so only borrow a specific amount for a specific purpose and before you borrow, make sure you can pay it back.
Also, shop around. Credit and loans are like cars, you can get a good deal if you compare products.
Lastly, never sign anything you don’t fully understand. Click here for more information on getting help understanding credit contracts.
Don’t treat credit like cash to spend on anything and everything. Only borrow a specific amount for a specific purpose and make sure you can afford to pay it back. It’s a great idea to shop around for the best deal on credit and loans, so do your research. And most importantly, don’t sign anything you don’t understand.
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