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Debt & Credit Overview
Few people can afford to buy everything they need in cash, so buying on credit is a necessity for most of us. However, borrowing money always has risks. Writing your own financial success story means you have to understand these risks.
Whether you’re taking out a loan for a big purchase like a home or car, or are using your credit card for smaller, everyday purchases, it’s important to know how to manage your risk wisely. By being informed about interest rates, your credit score and responsible borrowing practices, you can avoid common pitfalls and make the most of your credit opportunities.
In this guide, we’ll provide you with some helpful tips and insights into managing your credit, to help you make smart borrowing decisions.
Understanding Credit
As we said, credit is part of life and it’s a helpful tool if you know how to manage it properly. However, using credit wisely is not always easy, but it’s very important for building a solid credit history and staying financially healthy.
So, what is credit exactly?
Credit gives you the ability to buy what you need now and pay for it later. It's all about trust— that you’ll pay back the money in the future, usually with interest added. Simply put, when someone gives you credit, you’re borrowing money from a credit provider (like a bank) to use now, but this needs to be paid back over time at a cost.
It’s important to understand how credit works so that you’re able to use it responsibly.
Let’s look at the three elements that make up credit:
Risk
There is always a risk that you won’t be able to pay back the money borrowed.
The money is always borrowed over a period, for example, six months, 12 months or longer.
There are always costs involved in borrowing money. These costs include interest, initiation and service fees.
Choosing the Credit Option That's Right For You
With revolving credit, you get a maximum credit limit and you can make purchases up to that limit. Every month, you carry a balance over (or revolve the debt) and make a payment with interest. Credit and store cards are a form of revolving credit.
With instalment credit, a creditor loans you a specific amount of money, and you agree to repay the money and interest in regular instalments of a fixed amount over a set period. Personal loans and home loans are two examples of instalment credit.
A credit guarantee is when someone agrees to cover your debt if you can't pay it yourself. By signing a credit agreement as a guarantor, they promise to fulfil any financial obligations that you fail to meet. In South Africa, this is also known as signing surety.
Best Ways To Manage Your Debt
The Debt Snowball Method
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The Avalanche Method
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Debt Consolidation
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Snowflaking
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Debt Can Be Good, And It Can Be Bad
Once you have borrowed money (taken on credit), you have also taken on debt, however, not all debt is bad debt. Some debt is considered good debt. Good debt offers long-term financial benefits, while bad debt will hurt your finances. Knowing the difference between good debt and bad will make all the difference in the financial story you write.
Think of good debt as an investment in your future, like a student or business loan. Either of these has the potential to help further you personally and financially. Another form of good debt is debt that improves your standard of living, like a bond for a home or finance for a vehicle you need for your business or to get to work and back.
On the other hand, bad debt involves borrowing money for things that quickly lose value and don’t generate income, like using your credit card for everyday purchases, payday loans, or borrowing money to take a holiday.
The next time you buy something through a loan or credit, stop and think, Is this good debt? Is it something that will benefit me in the long term and contribute to my well-being, or is it debt that will put a strain on my financial stability and create an unnecessary burden in the future?