What is Credit?

What is Credit?

Credit is basically an amount of money that is lent to a person or a business, that must be paid back over a set period of time, with a set cost.  There are consequences for not paying back credit lent to you.

In the UK, credit is used by many people, for different reasons, for example to make a large purchase like a house with a mortgage or a car. Credit can also be used to provide some protection on purchases for example using credit cards, as credit card companies can step in to recover money if you are unhappy with the goods.

In the UK there are two types of credit:

Revolving Credit: this includes on-going amounts of money you can borrow, which consumers can spend flexibly, a credit card is an example of this.

Fixed Repayment Loans: this type of borrowing is a set amount related to a specific item for example a car or house.

How Credit is repaid:

It is dependant on the type of credit taken, as to how you repay it. With fixed repayment credit, it is generally paid back monthly in fixed amounts, over a set period of time, for example a personal loan. A mortgage often has a set cost per month, but it is possible depending on the terms of the mortgage, to overpay often up to 10% of the total amount per annum.

Revolving Credit means there is on-going access to an amount of credit, within a limit, so for example a credit card may have a limit of £5,000, every time you spend some of the available credit, this reduces the amount available to you. If you pay off some of the amount borrowed this will increase the amount available to you.

£5,000 limit, and you spend £500, in one month, this means in that month, the amount of credit available to you is £4,500. If you pay back the £500 at the end of the month, then the amount available to you goes back up to £5,000, as soon as this happens.

A very important point is, consumers must make payments on time, and repay the agreed amounts, with the lender. Credit Geeks has free credit repayment calculators, so use these to work out the costs of any credit.

How Credit Interest Works

If you want to obtain credit, there is a cost for doing so (this is how the lender makes money from lending) and this is often called interest or APR (annual percentage rate). When you repay credit, it will include the amount you have borrowed plus a charge (interest). Lenders often use a method called compound interest to calculate, how much you owe.

Below is a quick example of Fixed Repayment Credit like a loan, and highlights the different costs involved when the interest rate charge is different.

Amount to borrow: £10,000

Time period to repay: 3 years

APR (interest rate): 7.8%    

Monthly repayment: £312

Total payment: £11,247

Total interest charged: £1,247

Amount to borrow: £10,000

Time period to repay: 3 years

APR (interest rate): 15%

Monthly repayment: £346

Total payment: £12,479

Total interest charged: £2,479

From the above you see the difference between borrowing the same amount at 7.8% versus 15%, so £1,247. This is why having a good credit history is important to be eligible to obtain credit at the best interest rates.

Start building your Credit Score now by obtaining credit!

Without a credit history it is very difficult to obtain credit. So if you are new to the UK, or have not had credit before, best thing to do, is get a basic credit card, and use this to pay for everyday items, but pay it off in full every month. This may seem pointless, but what it is doing is developing a credit history for yourself. You will then need to check your credit report to see if your credit score is improving over time.

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