PRO TIP! Print this action plan and stick it up against your fridge. Tick things off as you go along.
When you take out credit, you use someone else's money to buy things and will need to pay them back with interest. Credit can be a powerful tool to build your financial future and make it possible to do things that you wouldn't be able to do otherwise, e.g. buy a home. Used for the right reasons, and with the right, responsible mindset, credit can benefit your financial situation without causing undue strain. Here is how to manage your credit prudently and responsibly.
Understand Key Credit Concepts
- Credit = Loans = Using Someone Else's Money: When we speak of credit, we are referring to borrowing money from a credit provider. This includes home loans, vehicle financing / car loans, credit cards, store cards, personal loans, and more. Keep in mind that, although you have might have easy access to spend the money on a credit card, for example, you'll need to pay it back — with interest. Never fall into the trap of thinking it is your own money.
- Realise That Items are More Expensive on Credit: Because you pay interest on top of the original purchase price, buying something on credit will necessarily mean that it will be more expensive in total than purchases made with cash. However, sometimes that is unavoidable, for example when buying a home or a car.
- Understand Secured vs Unsecured Loans: With a secured loan, you offer an asset as collateral for the loan. For example, when you buy a home or a car on credit, the bank has the option of selling your house or car should you ever be unable to pay off your loan. By contrast, unsecured credit (e.g. personal loans and credit cards) does not have that asset backing. Unsecured credit is generally significantly more expensive (i.e. with a higher interest rate) than secured credit.
- Know the Interest Rates: The interest rate that you are charged by a credit provider for your home loan, vehicle loan, credit card, or personal loan will vary. As discussed above, interest rates on home and vehicle loans are significantly lower than on credit cards and personal loans. Your specific interest rate will depend on your credit score and history. If you have a bad credit score, you will get worse interest rates from credit providers, and some may refuse to extend you credit, i.e. lend your money. Not sure what your credit score is? Reach out to us.
- Familiarise Yourself with Fees: Understand any fees associated with your credit accounts, like late fees, over-limit fees, balance transfer fees, and annual fees. Your credit provider will need to explain these to you carefully in your credit agreement document.
- Always Sign a Credit Agreement: You should always sign a written agreement for credit. If your credit provider does not furnish you with this, and explain the terms clearly, the National Credit Act dictates that they could be guilty of reckless lending.
- The Right Tool for the Right Job: Use different credit types (credit card, personal loan, overdraft) appropriately based on the financial need (e.g., daily purchases, large one-time expenses, cash flow management). Always use the available credit with the lowest interest rate.
Spend Within Your Means
- Budget For Credit: Use credit for purchases that fit within your budget instead of using it to extend your buying power beyond what you can afford. Make sure you always have enough room in your budget to repay your monthly instalments.
- Stick to Essential Purchases: Use credit for necessary expenses or items that bring long-term value rather than impulsive buys. The best example of an item that brings long-term value is a home loan.
Be Strategic When Applying for Credit
- Avoid Unnecessary Credit Applications: Only apply for additional credit if it’s truly needed and you have a plan for using it responsibly. Don't apply for credit just to see what you can get.
- Understanding the Impact of Inquiries: Remember that credit inquiries can affect your credit score, so apply for new credit sparingly. If you have too many credit inquiries in a short space of time, your credit score will be hurt.
Make Timely and Full Payments
- Pay on Time: Always pay your credit bills on time to avoid late fees and negative impacts on your credit score.
- Pay in Full: Whenever possible, pay off the full balance each month to avoid interest charges and reduce the risk of debt accumulation. A good example would be your credit card, which generally offers 55-day interest free credit. If you settle your full credit card debt at the end of each month, you won't pay interest.
Keep Your Credit Utilisation Low
- Stay Below 30%: Aim to use less than 30% of your available credit limit. High utilisation can signal to lenders that you’re over-reliant on credit and may be a risk. This will also hurt your credit score. Read more about how to build and maintain a good credit score.
Monitor Your Credit
- Regularly Check Your Credit Report: Regularly check your credit report for errors and understand how your credit behaviour affects your score.
- Report Any Errors: If you pick up any discrepancies on your report, e.g. accounts you don't recognise, or incorrect personal details, report the issue to a credit bureau as early as possible.
Manage Debt Proactively
- Understand Debt Strategies: If you find yourself in debt, take proactive steps to manage it, such as paying down high-interest debt first or considering consolidation for easier management. Read our article on the two key debt management strategies.
Keep Up To Date
- Engage in Continuous Learning: Stay informed about credit management best practices and financial literacy.
By using credit wisely, you're not only managing your current finances responsibly, but you're also setting the stage for a healthier financial future with a solid credit history that can benefit you in many ways, from lower interest rates to easier approval for rental applications and more.