9 Aug 2018

What kind of credit should I use?

Illustration of a book

Credit can be a convenient way of buying something now and paying later. But with so many types to choose from, which is right for you?

We look at four common types of credit below, and explain how they work and what they’re designed for.

Credit cards

A credit card is a form of ‘revolving credit’, which means you can keep reusing and repaying it (as long as you stay within the limit).

Most credit cards let you be flexible about how much you repay each month, although you’ll need to meet the minimum payment.

You’re usually charged interest on the amount you owe. Racking up card debt can get expensive, so it’s best to clear your balance every month if possible.

Credit cards often have high interest rates, but some offer an interest-free period. Some people use these to spread the cost of a big purchase over several months or years.

It’s a good idea to pay it off before the promo ends and your rate goes up.

You may want to shop around before picking a card, as there’s a huge variety available.

Suitable for: Small, short-term borrowing (but maybe longer if you can find an interest-free deal)

Overdrafts

An arranged overdraft lets you borrow money via your current account. It’s another type of revolving credit, and is best suited for small, short-term borrowing. So, if your car suddenly breaks down or the roof springs a leak, an overdraft could tide you over until next payday.

One common advantage overdrafts have over credit cards is that you can use them to get cash, without being charged more than usual for the withdrawal.

Using an overdraft usually costs interest and/or fees. A Monzo overdraft charges 50p every day you’re overdrawn by more than £20, up to a maximum charge of £15.50 a month.

Importantly, an arranged overdraft is different from an unplanned overdraft. This happens if you spend more than what’s in your account without the lender’s permission, or go over the agreed limit.

Suitable for: Small, short-term borrowing

Loans

A loan is a lump sum that you repay over several months or years, plus any interest or fees. Loans are commonly used for large, one-off expenses, like home improvements or a wedding.

They’re different from credit cards and overdrafts in a few ways. For example, you can typically borrow bigger amounts at lower rates with a loan, but you can’t reuse the funds once they’ve been repaid. Loans tend to give you less flexibility, as your payments will normally be the same each month.

Loans generally fall into two categories: secured and unsecured.

With a secured loan, you normally use your house or car as ‘collateral’. If worse comes to worst and you can’t repay the loan, the lender may use the collateral to recover their money.

Unsecured loans (also called ‘personal loans’) don’t require collateral, but you may need a healthy credit score to get one.

Suitable for: Large, long-term borrowing

Hire purchase or conditional sale

Hire purchase is a common option when you’re looking to buy a car, although it can be available for things like furniture too.

It’s a bit different to other forms of credit, and the clue is in the name. Essentially, you hire the car while making regular payments towards its cost and any interest. You aren’t actually the owner until you’ve paid in full.

Conditional sale is similar to hire purchase, except that you’re required to buy the car outright at the end of the agreement. Hire purchase gives you the choice to do this by paying an ‘option to buy’ fee.

In both cases, you’ll put down a non-refundable deposit at the start of the agreement.

Suitable for: Big, one-off purchases (especially if you can’t get a loan, but have enough for a deposit)

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