What is credit?

With so many types to choose from, how do they differ and how does credit work?

A simple description

Credit gives you access to money now, allowing you to spread repayments over a period of time. This could come in handy if you need to make a larger purchase, manage an emergency your usual budget won’t stretch to, or if you want to consolidate debts you hold elsewhere.

Lenders may charge you for using their services – usually interest as a percentage of anything you borrow. Other fees and charges may also apply.

How credit works

Although they all work slightly differently, credit account features might include:

Interest rates

The amount of interest you pay is worked out as a percentage of anything you borrow. The higher the percentage, the more it’ll cost to borrow. Generally speaking, the lower it is, the cheaper it’ll be to borrow.

Fees and charges

As well as interest, things like annual fees might apply to some credit accounts. You could also be charged for missed or late payments, going over your credit limit, cash withdrawals and using your cards outside of the UK. For specific details, check the terms and conditions for your account.

Regular payments

It’s usual that you’ll have to make monthly payments on most forms of borrowing, which is detailed in the terms and conditions for your account. You must make payments on time to avoid additional fees and charges, losing any introductory or promotional interest rates, and to limit any negative impact on your credit score and record.

A credit limit

Common on credit cards, overdrafts and store cards, this is the pre-agreed maximum amount you can borrow up to, without being charged additional overlimit fees. If you go over your credit limit, your credit score could also be negatively impacted.

Common types of credit

Below we’ve included a short description on the most common types of credit:

Mortgages

A mortgage is a type of loan, designed to help you buy a property, which the loan is secured against. Mortgage terms can be as long as 40 years, with both fixed and variable interest rates available. You usually need a deposit to apply for a mortgage.

Just be aware, if you don’t keep up with your repayments, you could lose your home.

On repayment mortgages, you’ll pay more towards interest at the start, and less as you reduce your balance over the mortgage term.

On interest-only mortgages your monthly payments could be lower, but you’re not reducing your balance during the mortgage term, and you’ll need to repay the full amount at the end.

More on mortgages

Personal loans

Offering a fixed borrowing amount, and repayment terms of 1-7 years, a personal loan could be a reliable and predictable way to borrow. At the end of your loan term, your balance will be repaid in full, as long as you’ve made all of the required payments.

If your interest rates are fixed, your payments will be too. Personal loans are also available with variable rates though, meaning your payment amount could go up or down. Make sure you check the product details carefully.

More on personal loans

Car finance

Before buying a car from a dealership, it’s worth exploring all of your financing options:

On a Hire Purchase (HP) plan, you’ll make fixed monthly payments over 1-5 years. At the end of your agreement you’ll own the car outright, with no mileage limits to think about.

Personal Contract Purchase (PCP) plans offer lower monthly payments over 1-4 years. At the end of the agreement, you can return, exchange, or pay a lump-sum to own the car. Just be aware that mileage and return conditions may apply.

More on car finance

Credit cards

A credit card can be a flexible option for spreading the cost of larger purchases, accessing cash in an emergency, or helping you to consolidate debts.

You can use a credit card in retail stores, online and at compatible cash machines around the world. It’s just useful to know that different interest rates, fees and charges might apply to individual transaction types.

More on credit cards

Overdrafts

An overdraft is a type of credit attached to your current account, which is best used as a short-term safety net, whether you need a little extra to cover unplanned expenses, or just to tide you over when you’ve run out of money.

Using an arranged overdraft carefully, i.e. limiting how much you use it, paying it off regularly and staying within your overdraft limit, can boost your credit score. The opposite is true if you manage your overdraft poorly.

Some banks and building societies will let you to use an unarranged overdraft, but your credit score could be negatively impacted if you do.

More on overdrafts

Store cards

Some retail brands offer credit, allowing you to make purchases with one individual brand or store. Some may also offer tailored benefits and loyalty rewards.

As with other credit products, interest, fees and other charges may apply, and you’ll need to make regular repayments.

These shouldn’t be confused with cards used solely to collect loyalty points, or retailer branded credit cards, which can be used to make purchases elsewhere, and for other types of transaction.

Unsecured borrowing

As well as more traditional forms of borrowing, you might see options like PayPal Credit when you shop online, which could help you to spread the cost of larger purchases over a few months.

As with any types of credit, it’s important to keep up with repayments to avoid any negative impact to your credit score.

‘Buy Now Pay Later’

Companies like PayPal, Klarna and Clearpay give you the option to make online purchases now, and pay in instalments over a few weeks or months.

This service could be offered with no interest, fees or impact to your credit score, as long as you keep up with your payments, making these popular for short-term borrowing. If you miss a payment, fees and charges may apply.

Student loans

Although often offered at low interest rates, a student loan is still a form of debt, which could affect your credit eligibility and score until everything is repaid.

As with any other type of credit, missing a student loan payment might have a negative impact on your credit score.

Where can you get credit?

Below we’ve listed the main lender types here in the UK:

Banks and building societies

Most people have at least a bank account with an institution, like Halifax, helping them to manage their money and borrowing needs.

Offering the widest range of credit products, banks and building societies often provide mortgages, credit cards, loans, overdrafts and car finance, under one roof.

Retailers

Supermarkets, department stores and some other service providers offer credit options, including:

  • Store cards or accounts, so you can make purchases with a single brand or store.
  • Branded credit cards, which can be used to make purchases elsewhere, and for other types of transactions, such as balance transfers. These may be provided in partnership with a bank.
  • Finance agreements on larger purchases, such as furniture, a car or electrical items.

Credit unions

These are non-profit co-operatives run by members, for members, most commonly formed by groups with close associations, like trade unions or social clubs.

They might offer loans to their members, in addition to current or savings accounts.

Short-term lenders

Sometimes referred to as ‘pay day loans’, some companies offer flexible borrowing options which could tide you over for a short period of time.

There is now a cap on the amount of interest these service providers can charge, but the costs are still likely to be much higher than other longer-term borrowing options.

Secured or unsecured borrowing?

 

Secured borrowing includes things like mortgages and some forms of car finance, where the money you borrow is secured against one of your belongings, such as your home or car.

If you don’t meet the terms and conditions of your credit agreement, such as making regular repayments on time, your property could be repossessed. In addition, it’s likely to negatively impact your credit score.

A benefit of secured borrowing, however, is that your interest rates may be lower.

Unsecured borrowing includes things like credit cards, personal loans and overdrafts, where the money you borrow is not secured against your belongings. But borrowing costs could be higher.

It’s still important to manage these accounts carefully. If you don’t meet the terms and conditions of your credit agreement, including making regular repayments on time, your credit score might be negatively impacted, which could make it harder for you to get credit in future.

Tips for managing credit

  • Only borrow what you need and can reasonably afford to repay. Try to find introductory or promotional interest rates if they’re available to you.
  • Make sure you understand the cost of borrowing, including interest, fees and other charges.
  • Check your statements and online accounts regularly, helping you to keep track of your balances, transactions and payments.
  • Make payments on time to avoid extra fees and charges, losing any introductory or promotional interest rates, and to limit any impact on your credit score and record. Setting up a Direct Debit could be one way to ensure you pay on time, so long as there are funds available in your nominated bank account when your payment is claimed.
  • Try to repay as much as you can, reducing your balance and the amount of any interest you pay overall. Just be aware that early repayment charges may apply. This could also stop you falling into persistent debt.
     
Knowing what you can afford

What is a credit score?

When you apply, lenders and service providers contact their preferred credit reference agencies to check your credit record, which may highlight any potential risk of offering you credit. This information could also influence any interest rates and the amount of credit offered.

Not only that, but lenders and other service providers do their own credit scoring (PDF, 69.8kb) when you apply for credit, looking at information from your credit record. They also consider other factors like affordability and any past account history.

More on credit scores

How credit affects your credit score

How you use and manage credit is just one thing which could influence your credit score, although the amount you borrow, the age of your accounts and how well you manage payments and credit limits can all affect your rating.

Other factors include whether or not you’re on the electoral register, how often you move and change addresses, how well you manage household bills, and even the credit history of someone you have joint accounts with.

What affects your credit score?

A summary on credit

Credit gives you the option to purchase now, and repay what you’ve borrowed over a period of time.

  • Interest, fees and charges might apply to anything you borrow.
  • There are lots of credit options available, including personal loans, credit cards, mortgages, car finance and overdrafts.
  • Borrowing can be either secured, like a mortgage, or unsecured, like a credit card.
  • To avoid additional fees, charges and any negative impact to your credit score, you must make repayments on time and stay within any pre-agreed credit limits.

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