Understanding the Different Types of Credit Available

There are many types of credit available and it is important to understand how each works so you’ll learn to manage and use them to your advantage.

1. Loans

When you take a loan, you borrow money that must be repaid with interest. You can obtain a car loan for financing a new car, student loan to pay for college tuition and a home loan (mortgage,or home refinance) to buy or renovate a home. You can also get a debt consolidation loan, which combines all current debts from various credit lenders into a single reduced-interest payment plan.

Loans are generally divided into two types: secured and unsecured:

  • Secured loans:

    These loans are guaranteed by collateral (security). Your personal property most of the time is used as the security for this type of loan. Although you may get a good interest rate, if you can't keep up the payments, your property can be repossessed by whomever you owe the money to. A mortgage is a common example of a secured loan, where you can end up homeless if you default on the repayments.

  • Unsecured loans:

    These loans don’t require collateral and are made based on your credit score and ability to repay. It’s prudent therefore to shop around for the best interest rates, and be absolutely certain that you can afford the monthly repayments because if you don't pay up, you can be rest assured they’ll come after you.

2. Overdraft

An overdraft occurs when withdrawals from a bank account exceed the available balance. It comes in handy in case you write a check for an amount that exceeds your account balance. If there is a prior agreement with the account provider for an overdraft protection plan, and the amount overdrawn is within this authorized overdraft limit, then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may be charged and higher interest rate might apply.

3. Credit Cards

With credit cards, you can make repeated transactions up to a maximum credit limit. Each time you charge something, you are borrowing the money until you pay it back. If you decide to pay the money back over time, the credit card company adds finance charges to your account. Each month, you will pay a calculated amount until the borrowed amount is repaid.

4. Hire Purchase

Hire purchase is another common way of paying for major items, such as furniture, electrical & electronic appliances and other household or business goods. The goods you buy belong to you straight away but you don't legally own them until you've paid back all the money you owe. This means that you cannot modify or sell them without the lender's permission. So, you need to think carefully before committing yourself.

5. Pawn broking

With this option, you give your personal possessions to the pawnbroker, and they lend you money for a specified period of time. You then have to pay the money back to retrieve your belongings; otherwise the pawnbroker gets to keep the items.

6. Loans from Shylocks/Loan Sharks

Above all other sources of borrowing, avoid these guys. These folks lend money at excessive rates of interest and who don’t find it an issue to use intimidating methods, threats or force in order to obtain repayment.