Unit 2
Borrowing money: credit
This chapter focuses on how to 100% bankrupt yourself. Remember 2008?
Table of Contents
Why borrow money (use credit)?
| Reasons for | Reasons against |
|---|---|
| Immediate satisfaction – get now, pay later | Interest charges – cost of borrowing can be quite high |
| Convenience – credit cards are easy and smaller than cash | Impulse buying – it’s easier to buy more goods/more expensive items |
| Savings and discounts – credit card promotions | Fees – Merchant costs and surcharges |
| Emergencies – Access to money for unexpected expenses | Loss of control – Lose control of finances |
| Higher quality of life – Access to more assets can improve your life | Inability to repay – Ruin your quality of life and make you unhappy |
| Forced ‘saving’ – must put aside money to pay for repayments | False sense of security – skewed perception of how wealthy you are |
Loans
- How much to borrow?
- Do I have enough money for a deposit?
- Can I meet my repayments?
- Is it the best deal?
There are many different types of loans from a variety of financial institutions:
- Personal loans – used to purchase cars, furniture, travel or other. Available as:
- secured loan – something is deposited as a guarantee to fulfill payment of the loan
- unsecured loan – nothing is deposited as a guarantee to fulfill payment of the loan
- Mortgage loan or a home loan - used to buy a house, which also serves as security for the house
- Bank overdraft – when cheques are written with an amount greater than their account balance, used for example when businesses have a cash flow (money in a business) problem and need to pay suppliers
- Credit cards – electronic cards that allow a user to make electronic transactions using credit. Incurs no interest and is convenient but has a spending (credit) limit and has high charges.
- Store credit – cards that permit a user to buy products on credit at stores
- Payday loans - cash advance against pay slips for a few hundred dollars, with high interest and fees
Interest
You have to pay interest – payment made for the use of money that has been borrowed. Interest is usually expressed as a percentage (e.g 12.5%) and interest is usually expressed as ‘per annum’ (pa) – which means ‘yearly’.
To calculate interest, visit Financial Mathematics
Credit rating
Your credit rating is a reputation for your ability to repay a loan. It is determined using the ‘three Cs of credit’.
- Character – your reputation for repayment
- Capacity – your ability to repay
- Collateral – your security if you cannot repay
The world of debt
Persons who owe money are known as debtors or borrowers, and persons owed money are creditors. Creditors can take legal action against you if you fail to fulfill obligations to the creditor.
Each individual has to establish different credit limits based on risk and ability to repay. This means someone with no dependants and a small apartment can handle more debt than a large family and house. Ability to repay is linked to your financial position, including:
- present and future income
- value of assets
- outstanding debts
Failing to repay debts can result in repossession (compulsory acquisition of goods bough on credit should debts not be repaid).
Guarantor
**People with poor credit ratings might need a guarantor: someone who guarantees to pay back money if the borrower does not. **
Usually people go guarantor because they love/trust the person and are unaware of obligations as a guarantor. Before going guarantor, someone should receive a copy of the loan contract, and an explanation of rights and liabilities if the debt isn’t paid.
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