Secured, unsecured, bond, credit card? What does it all really mean?

 

What’s the history of credit?

Consumer credit is believed to have been invented in 3500 B.C. Originally thought up by the first populous city, Sumer. Loans were issued for agricultural purposes to help people start farming themselves. Modern day formalised credit only popped up in 1919 when the introduction of the consumer car by Ford made instalment financing necessary to allow consumers to pay off larger items over time.

From there, the credit boom started. Through the ages, variations of credit have sprung up to help consumers bridge the gap in financing their expenditure while managing their daily cashflow needs to maintain their lifestyle. The availability of this credit ultimately promotes spending – which allows consumers to forgo future consumption for today’s needs.

 

What Type of credit products are out there?

Broadly speaking, you get two forms of credit in South Africa – secured and unsecured. The difference relates to what security the lender has over the money they’ve lent you. Consider a bond to buy a house – if you miss repayments on your bond and are no longer able to afford them, the lender can sell your house to pay back the loan. This process is what you see at auctions as banks try to offload assets. They do this to settle their debt as a result of a consumer defaulting on the repayment. In this example, the house was the security to the lender. In terms of vehicle financing, the car is used as collateral should you be unable to repay the loan.

 

What about unsecured credit?

“Unsecured” credit implies the lender has no security to hold on to and is therefore at higher risk. The lender may charge higher rates and keep loans shorter in term to avoid opening themselves up to greater risk. Credit cards, store accounts and personal loans all fall into this category. In order to contribute to the remaining balance on your credit card, you will be required to pay a minimum monthly amount. Credit cards and store accounts enable purchases that have limited to zero resale value – think clothing, food or experiences funded by credit. With personal loans, you must pay back the loan in monthly instalments, but with an added interest rate.

 

Tell me about credit repayments 

If we dive a little deeper, there are two central types of credit repayments. Firstly, there is installment credit. Installment credit is distinguishable by the prearranged length and end date of the credit account. With installment credit, there is usually an agreement which states a repayment schedule. Your primary amount is reduced every time you contribute to the repayment. You will know how much you have to pay per month and for how long you will be required to make these payments.

With revolving credit, credit cards are probably the most identifiable type. With revolving credit, the credit limit does not change once you make a payment. You can continuously go to your account and borrow additional money, as long as you do not exceed your maximum. You can borrow up to a certain amount, but because of this flexibility, there are often lower borrowing amounts and higher interest rates.

 

Which credit repayment method is better for my credit score?

Revolving credit is typically a riskier way to borrow in comparison to installment credit. This is especially true when taking your credit score into account. Your credit utilization rate makes up a significant share of your credit score. Your credit utilization rate looks at your overall limit of each card and how close your bank balance is to this limit. Therefore, if you are carrying high balances, your credit score will drop. It’s in your best interest to find out your credit score so that you can manage and understand your current credit utilization. You can get a free credit score here so that you can manage your credit.

 

 

Join us next week as we dig deeper into the credit space in South Africa and how lenders manage their debt.