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Understanding Credit

In today’s world, credit is a part of everyday life. It can be a helpful tool and a very useful asset in our everyday lives, but only if we understand it and manage it properly.

When you pay for something, you usually have a choice of how to pay: cash, debit order, lay-by, cheque, debit card, or a credit or store card. Using a debit or credit card has become more popular, and is often just easier to use.

That said, credit cards have become a necessity in today’s world, for shopping online, renting a car to re- serving an airline ticket or hotel accommodation. Also, credit is needed for large purchases, such as for a house or vehicle, or an unsecured loan for a property extension or education costs. Using credit wisely is unfortunately not a skill practiced by everyone, but it is vitally important for building a solid credit history and staying financially healthy.

There are many reasons why you might borrow money. The biggest reason why someone might use credit is because there is a desire to buy something now and pay for it later. It is especially useful to use credit to make a large purchase that you cannot afford immediately, so you can buy it now and pay it off in installments over time, because most people cannot afford to buy a house or a vehicle with cash. When you have an emergency, it is great to use credit because you might not have had time to save to pay for what you need right now.

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If you borrow money from a bank or other formal lender, you will hear the following terms associated with your loan. It is important to understand what each means for your specific loan.

  • Principal: The amount you borrow (the amount deferred in terms of the credit agreement), to which interest, fees, collection costs, default administration costs and credit insurance are added. These will be dealt with in more detail in Section 7.
  • Loan term or repayment period: Period you have to use the loan money and repay it.
  • Repayment schedule: How often you will make loan payments in instalments, for example weekly or monthly.
  • Instalment: When debt is divided into parts, an instalment is one of the parts that is paid at specified intervals. So it is the amount of money you need to repay every month to pay back the money you borrowed.

While using credit for reasons such as purchasing a house or an emergency, credit can be used for the wrong reasons too. Bad uses of credit would be:

  • Using one credit account to pay another credit account Paying for things you really cannot afford (other than a house or a car), because chances are that if you cannot afford it today, you won’t be able to afford it tomorrow or next week
  • Using credit to make ends meet
  • For gambling
  • For maintaining a certain appearance to the outside world

If we had an economy based only on cash or trade, then we wouldn’t need credit. However, when people need to have a product or service that they cannot pay for in cash, credit allows them to do so. However important credit may be, while everyone has equal access to credit under the NCA, it is not possible for everybody in South Africa to receive credit. The giving of credit is based largely on trust. This means it has a certain amount of risk that is involved. This risk is often mostly carried by the credit provider.

How credit works

You need to understand how credit works so that you will be able to use credit more responsibly in order to secure your financial health and achieve your personal goals for the future. Simply put, when credit is given to someone, he/she borrows money from a credit provider to use now, but this needs to be paid back over time at a cost. Based on this explanation, credit has three elements:

  • Risk: There is always a risk that a person will not be able to pay back the money borrowed.
  • Time: The money is always borrowed over a period, for example six months, 12 months or longer.
  • Costs: There are always costs involved in borrowing money. These costs are interest, initiation and service fees.

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Credit can definitely be a useful tool and certainly has its advantages, such as buying something now and paying for it later. However, it also has some disadvantages and dangers, such as being in debt, that need to be considered. Not all debt is bad, but having too much is. Mismanaged credit and debt can have serious consequences for you.

You should make sure that you use credit for the right reasons, and that you don’t overuse it. While you may be able to afford your instalments this month, or even the next six months, you don’t know what the future holds. And it is hard to recover when you are forced to skip a couple of instalments.

Take Note

Some of the other dangers of debt and credit include:

  • If you are unable to repay debt, the credit provider loses money, and this has a negative effect on our economy.
  • Bad debt leads to legal action and has further financial consequences.
  • When you fail to pay it back, more interest and fees are added, which only increases your debt.
  • If collateral such as a house or a vehicle is used to guarantee a debt, this may be seized and sold to help recover the outstanding debt.
  • It may lead to over-indebtedness, where you are unable to save money and then rely on credit for future purchases.
  • Money is tied up repaying debt.
  • Credit may lead to overspending or reckless spending.
  • Credit is not free; it costs money to get money.

You receive electricity, a cell phone service, gym membership, and so forth, with the agreement that you will pay for them each month. This agreement becomes a credit agreement when you don’t pay, and then you are charged interest and costs, and legal action can be taken. Mostly, these are not shown on your credit report (except cell phone contracts, which are shown) until you don’t pay and it becomes an incidental credit agreement.

Types of credit

Credit can be divided into three general categories:

  1. Credit facilities (revolving credit): With revolving credit, you are given a maximum credit limit, and you can make charges up to that limit. Each month, you carry a balance (or revolve the debt) and make a payment. Credit and store cards are a form of revolving credit.
  2. Credit transactions/Instalment credit: With instalment credit, a creditor loans you a specific amount of money, and you agree to repay the money and interest in regular instalments of a fixed amount over a set period. Personal loans and mortgages (home loans) are two examples of instalment credit.
  3. Credit guarantee: This is when a person undertakes or promises to satisfy upon demand any obligation of another consumer in terms of a credit facility or a credit transaction. They sign a credit agreement as a guarantor and promise to pay should you not be able to pay. In South Africa we also refer to this as signing surety.

Whichever credit you use, remember: It costs money and you need to be able to afford it.

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The National Credit Act

The most important piece of legislation that governs credit in South Africa is the National Credit Act 34 of 2005 (NCA). The aim of the NCA is to:

  • Increase access to credit at reasonable rates by reputable credit providers;
  • Promote a fair, competitive and sustainable credit market;
  • Help consumers make informed decisions;
  • Create mechanisms to deal with debt; and
  • Provide protection for consumers, securing redress (which means you have options available to com- plain or take action) and ensuring compliance from stakeholders, such as credit providers.

The NCA was introduced primarily to protect YOU as the consumer. The purpose of the NCA is to:

  • Promote a fair, non-discriminatory marketplace
  • Improve standards of the consumer credit industry
  • Prohibit unfair practices
  • Promote responsible credit granting
  • Regulate credit information
  • Provide for debt restructuring in a regulated environment

The key features of the NCA are as follows:

  • The language of credit agreements must be simple and understandable.
  • A pre-agreement statement and quotation, which is binding for five days, must be given for all credit agreements.
  • All advertising and marketing material must contain prescribed information on the cost of credit, and is prohibited from using specific terms.
  • A credit provider cannot sell credit sales at a person’s home or work unless with arrangement.
  • If a credit application is declined, the credit provider must give the reasons to the consumer.
  • Reckless lending is not permitted, and credit providers must take all reasonable steps to determine a consumer’s creditworthiness and affordability before granting credit.
  • The charging of interest and fees is regulated for all credit agreements, including micro-loans.
  • Consumers have the right to a free credit report from a credit bureau once a year.
  • It introduces debt counseling, which involves the restructuring of debts for over-indebted consumers.

Understanding Credit: FAQ

What is credit?

Credit is the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future, usually with interest. The National Credit Act (NCA) defines it as a deferral of payment of money owed to a person, or a promise to defer such a payment, or a promise to advance or pay money to or at the direction of another person.

What is a credit agreement?

It is a legally binding contract between a lender (credit provider) and borrower (consumer). It is an agreement to loan you a certain amount of money for a specified period. It outlines all the rules and stipulations associated with the contract. It also includes the details of the borrower and lender, monthly repayments, the loan amount, loan period and interest rate.