Using credit is about borrowing money. There are lots of different ways to do it. Advertisements for credit cards, store cards, personal loans and mortgages are everywhere.
Understand what choices you have and find out what you will have to pay in interest, fees and charges. How much more will it cost you to buy that television on your credit card instead of paying cash?
It can be tempting to shop now and pay later but the reality is that borrowing money can be risky. If you take on too much debt, you may not be able to keep up the repayments if you get sick or lose your job. If you get into trouble with credit cards when you are young, you could have problems later in life if you want to borrow money to buy a house.
Credit can be good. It can help you achieve your goals. But it pays to be careful. Understand when and how to borrow money and avoid the pitfalls.
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The bottom line
- Credit can be convenient but cash can be cheaper.
- It pays to shop around before borrowing money. There are big differences in interest rates, fees and charges.
- If you only pay the minimum payment on your credit card each month, it will take a lot longer to pay off and will cost you a lot in interest.
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Borrowing money
You are borrowing money when you use a credit card or store card, buy something on interest-free or no-repayment terms, or have a bank overdraft, a personal loan or a mortgage.
When you borrow money, you have to sign a credit contract which is enforceable by law. Both you and your lender have responsibilities under the contract. You must pay back the borrowed money and pay interest, fees and charges. Your lender must give you full information about the loan, including what you will pay and any terms and conditions that may apply.
Personal loans and mortgages have to be repaid in full by a fixed date. Other types of loan, such as credit cards and store cards, are more flexible. You need to make a minimum payment every month and you continue to owe the outstanding balance until it is paid off. You can borrow more money each month by making new purchases. These are added to what you owe. You are charged interest on the outstanding balance each month, although some cards have an interest free period for new purchases.
Credit cards and store cards are flexible and convenient but can cost you a lot in interest if you don’t pay them off quickly. If you only make the minimum repayment, credit and store card debts can take a long time to pay off. And you pay interest for as long as you owe money on the card. See More information.
Interest, fees and charges
You have to pay to use borrowed money. The cost of credit includes interest, fees and charges.
Interest may be calculated either on the amount of money you have borrowed or on the outstanding balance. Your balance can include accumulated interest, so you can find yourself paying interest on interest. Generally, the more money you borrow, the longer it takes to pay off and the more you will have to pay in interest.
The type of interest will depend on the product and the lender. Personal loans usually have fixed interest or variable interest.
Fixed interest – a set interest rate which does not change over the term of the loan.
Variable interest – an interest rate that can go up or down over the term of the loan.
Some credit cards offer interest-free days, others charge ongoing interest.
Interest-free days – a set number of days (for example, up to 44 days), before interest is payable on your purchases. If your purchases are not paid off in full by the end of the interest-free period, interest then applies to the entire balance owing.
Ongoing interest – an ongoing rate of interest which usually applies from the date you make the purchase. Generally, these cards have a lower interest rate than those with interest-free days.
You usually have to pay fees and charges as well as interest. These can include annual fees on credit cards, administration fees on personal loans, and redraw fees or early repayment fees on mortgages. See More information. The lender has to tell you what fees and interest rates apply to your loan and when they will apply.
You can compare the costs of fixed term loans by looking at the comparison rate. This shows the cost of the loan, taking into account the interest rate and fees and charges. For example, a personal loan advertised at 7.59% may have a comparison rate of 9.47%.
Lenders offering fixed term loans must:
- include the comparison rate in advertisements for loans
- give you a schedule of comparison rates with your loan application
- have schedules of comparison rates available for you to see at their premises.
The comparison rate is a useful way to compare loans but it does not include all fees and charges and does not apply to credit cards and overdrafts. It is a requirement of the Consumer Credit Code. See More information.
What type of credit is best for you?
You choice of credit product will depend on how you want to use the money, and your financial circumstances.
Credit cards
- let you borrow up to a pre-set limit
- let you keep borrowing so long as you pay back enough to stay below the limit
- may have a penalty charge if you don’t make the minimum monthly payment
- usually have higher interest rates than other forms of credit
- can cost a lot in interest if they are not paid off quickly
- are best used as a short-term credit option for making smaller purchases.
Store cards
- a type of credit card for use in particular retail stores
- may charge less in fees and have a longer interest-free period than other credit cards
- may charge higher interest than other credit cards.
Charge cards
- do not allow you to carry debt over from one month to the next
- you are supposed to pay the balance in full each month
- if the balance is not repaid, you may have to pay large penalty interest rates and fees and some lenders will also cancel the card
- some have no preset spending limit so if you are not careful you can end up with a monthly balance you can’t afford to pay off.
Interest-free or no-repayment terms
- may be available at some large retailers and department stores
- let you buy a big-ticket item such as a fridge and either have nothing to pay for a set period or commit you to making regular set repayments
- can be a good way to make large purchases if you can make all the required payments on time
- if you do not pay by the set date or if you miss a payment in the period, you will be charged interest which can be much higher than other forms of credit and may be charged on the full purchase price rather than the outstanding balance.
Personal loans
- you borrow a set amount which you agree to repay within an agreed period
- typically used for specific purchases such as a car or a holiday
- tend to have lower rates of interest than credit cards
- the credit contract will specify the amount borrowed, the purpose of the loan and the repayment arrangements
- can be secured or unsecured
- a secured loan may have a lower rate of interest than an unsecured one
- if you take out a secured loan, the lender holds security over one of your assets, for example, the car you have bought with the loan
- if you don’t make the repayments, the lender has the right to repossess the asset and sell it to recover the debt.
Mortgages
- a type of secured loan typically repaid over 10 to 25 years
- you borrow the money to buy a house and your lender has security over the property.
Overdrafts
- may be available on application for your bank, building society or credit union transaction account
- allow you to borrow money up to a specified limit
- you will be charged interest on the overdrawn amount and you may have to pay fees and charges as well
- if you overdraw your accounts without prior agreement you may have to pay high penalty fees.
Before you use credit
Think about whether you can avoid using credit. If you can pay cash instead, you save on interest, fees and charges. You can also save if the retailer offers cheaper terms for cash purchases. It can pay to wait and save for the purchase rather than use credit. Another option if you don’t mind waiting is to buy things on lay-by.
If you are going to use credit, it pays to shop around and do your homework. Whether you are thinking about a credit card, a personal loan or a mortgage, shop around for the best deal on interest rates, fees and charges.
Payday lenders (also called fringe lenders) typically charge a lot more to borrow relatively small amounts of money over short time periods. Be wary of loan advertising that says how easy it is to borrow but doesn’t say what it will cost. Be especially wary of advertising that attempts to sell a particular loan as a way out of your money worries. Look out for this type of advertisement just after Christmas and at other times when you may have spent more than you intended and may be worried about your debts.
It is possible to take out loan insurance when you get a personal loan or mortgage. This can cover your repayments if you lose your job or die. Your lender may offer loan insurance. It pays to compare prices. You may be able to get cheaper cover from an insurance company.
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Make it happen
- Think about whether you can afford the repayments. Is there room in your budget for the extra commitment? See Budgeting.
- How much is the item going to cost you over time, once you add interest and fees and charges?
- How long will it take to pay off the loan? The longer you take to repay, the more you are likely to pay in interest.
- Will you be able to keep up the repayments if you lose your job or get sick?
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Some lenders provide loan calculators to help you work out how much you can borrow, what your repayments will be and how long your loan will last. They can often be found on lender’s websites or in branches. See More information.
What will your lender do when you apply for credit?
The application form for the card or loan will ask you questions about your employment status, income, savings and existing debts. Your lender will use this information and your credit report when deciding whether to approve your loan.
In Australia, credit reporting agencies hold reports on individuals who have, at some point, applied for credit. If you have applied for a loan, a credit card or even a telephone account, you probably have a credit report.
Credit reports contain information such as the types of credit you’ve applied for and any overdue repayments of 60 days or more where you’ve been sent notice of the default and the credit provider has taken steps to recover the amount.
If you’re thinking of applying for credit, it’s a good idea to check your credit history first to make sure the details listed are accurate and up-to-date. Sometimes, the first time people become aware of their credit report is when a loan or credit application is declined. This occasionally happens as a result of an incorrect listing on your credit report, or an error in your personal details.
You can get a copy of your credit report from a credit reference agency. ASIC’s FIDO website has details of credit reference agencies in Australia. See More information.
If things go wrong
Help is available if you find your debts getting out of control.
Don’t ignore your debts. They won’t go away by themselves and there can be serious consequences if you let them build up. A few simple steps can help you simplify your finances, cut your interest bills and take control of your money. See Controlling your debts.
More information
There's a lot more that you can find out about borrowing money. See More information.