Guide: Applying for credit
‘Credit’ is the general name given to a sum of money that is made available for someone to borrow. This could be money that is borrowed and repaid over a very short space of time, or credit with a repayment period of months or years. Credit comes in useful in a wide range of situations – for example, it may allow a large purchase to be made, such as a house or a car, where the borrower doesn’t have the entire purchase price up front but can borrow it from a lender and then pay it off in installments. This is a short guide to applying for credit and the easiest ways to make sure that you borrow responsibly.
What kind of credit is available?
Credit comes in many forms. Credit cards are perhaps one of the most easily recognisable forms of credit and allow someone to pay for purchases with the balance on the card and then repay the credit company at a later date. Credit cards usually offer the option of paying the entire amount off or making payments of a ‘minimum amount,’ which is usually just enough to cover the interest that is payable on the money borrowed.
Loans are the other main form of credit, where a lender loans an amount of money to a borrower, which is then paid back in installments over a period of time. The loan might be for a specific purpose – for example, a mortgage loan to fund the purchase of a house – or it might be a more general loan that the borrower is going to use for something else.
Payday loans are one of the shortest term loans and are usually repaid over a period of around a month – they are borrowed to provide someone with finance until the next payday comes around. Personal loans often offer the same borrowing terms except that the repayment period is longer and, rather than the loan being repaid in a single installment, it is divided up into smaller repayment amounts that are paid over a longer period of time.
Which type of credit is best?
The type of credit that works best will depend on what the money is to be used for and how the borrower wants to make the repayments. For smaller loans that are to be repaid quickly, payday loans are ideally suited. Larger amounts of money, and less pressure to repay straight away, are better structured as personal loans, payable in numerous installments. For something specific, such as a house or car, a mortgage or a car loan respectively are the best products.
One of the features of credit is that interest is usually payable on the amount borrowed. The only time this won’t apply is where credit is available for an interest free period – for example, many credit cards might offer an initial interest free period for the first six to 18 months. The rate of interest is set by the lender (often by reference to the Bank of England base rate) and is always made known in advance to the borrower. For payday loans, for example, the rate of interest is usually around £25 for every £100 that is borrowed. Generally, where a sum is borrowed over a longer period of time more interest will be payable but the repayment amount may be smaller. So, for example, with personal loans that are borrowed for just two months, there will be less interest to pay but the entire amount must be repaid in two large repayments; this is in contrast to personal loans repaid over 12 months, where there will be more interest to pay over the 12 month period but the monthly repayments on the loan will be smaller.
A credit report is essentially a collection of information that is designed to show how well someone can manage borrowing. Lenders will usually consult a credit report before deciding whether or not to extend credit to a borrower. The credit report will contain details of all previous borrowings, including mobile phone contracts, mortgages, credit cards, overdrafts and will help lenders to decide whether or not to approve an application.
A credit score is based on information in a credit report or credit file. It’s a numerical score that is reached by a credit reference agency analysing the various factors in the credit report or credit file. Most credit scores will essentially provide an estimate of the risk that a lender is incurring by advancing credit to a borrower i.e. the likelihood of any failure to make repayments on the loan that is made over the next couple of years. There are a number of factors that can affect a credit score – for example payment history, such as late or missed payments, the length of credit history (a longer length is preferable), how many new accounts have been opened over a short period of time, as well as matters of public record, such as bankruptcies or judgments.
How to apply for credit
You can apply for most types of credit online, whether that’s payday loans or a credit card. You will usually be asked to provide information about your income, your current and previous addresses and your employment status. Applicants usually have to be at least 18 years old to apply for credit in the UK, as well as a UK resident with a UK bank account.
If you’re applying for credit then it’s crucial to make sure that you can actually afford to borrow it. Credit can sometimes appear to be ‘free money’ but remember that this is not the case and that you will pay interest on everything you borrow. It’s easy to get into trouble with borrowing if you don’t repay on time or work out whether you can afford it. Remember to factor in interest payments, as well as the repayments of the borrowed amount, and be sure that you can still cover all your regular living expenses, as well as the repayments you’ll need to make to the lender that has extended the credit to you.