Credit is a useful tool Australians can use to manage their finances. Unfortunately, when used incorrectly, it can create problems and leave us with additional debt to pay off. This is why credit health – the behaviours and attitudes we harbour towards credit – is so important. By understanding the different types of credit and how to use them properly, Australians can safely use it as part of a more holistic financial tool kit without falling into a debt trap. On its own, credit is neither a good nor a bad thing for our finances. It’s how we choose to use it that makes the difference. Credit comes in several different forms, from credit cards to personal loans and even mortgages.
There are three groups of credit:
- Short term credit typically paid off in 1 year eg Credit card, buy now pay later
- Medium term credit typically paid off in 1-10 years eg personal loans and vehicle finance
- Long term credit typically paid off in more than 10 years eg mortgages
Each of these three credit types have different repayment obligations and associated fees, and therefore are better suited to different types of transactions. You wouldn’t try to buy a house with a credit card, nor should you need to take out a mortgage to cover your cash flow for one month. Always match the credit you use with the timeline you’re working to. Understanding the different types of credit is a good first step towards good credit health. The next step is to understand the different ways to use credit properly. Much like credit types themselves, there are three main reasons why people borrow money:
- To buy something sooner
- To invest and grow wealth
- To manage cash flow shortfalls
Importantly, while it’s okay to use credit to cover your bills when you have an unexpected cash shortfall, you shouldn’t be relying on credit to cover bills regularly. Borrowing money to pay your living expenses can send you into a debt spiral. If you’re regularly turning to credit to pay your bills, you might need to consider redoing your budget.
The key to using credit effectively is to always stay on top of how much you’ve borrowed, how much you owe, and when your repayments need to be made. The golden rule is to only borrow what you need and can afford to repay. Although that might seem obvious at first, ask yourself this: Have you considered how much your repayments might increase in the future? What about your living expenses? How will changes in these two figures affect your ability to make repayments?
Tips to stay on top of your credit
Pay down your debt quickly. For short-term credit lines, try to pay off what you owe before the interest free period ends. Put a cap on how much credit you use, and reduce your credit card limits if possible. Make your repayments on time. Try to set up automatic payments if you can, or set reminders for yourself. If you can’t make your repayments on time, speak to your credit provider early and make arrangements for a late payment. Consider consolidating higher interest debt such as credit card repayments into lower interest loans to save on your interest where possible.
Understanding credit scores
When a credit provider is reviewing your application for a loan, mortgage, or even finance for a new mobile phone, they will review your credit report and credit score. These credit reports are kind of like the report cards you received in school, showing how much and how often you’ve borrowed money, and how well you paid it back.
Fixing or maintaining your score
Whether you’re trying to repair a bad credit score or simply maintain a good one, there are several simple steps you can take to improve your credit health today.
- Pay down your existing debt on time
- Get rid of unused credit limits – having too much credit will hurt your credit score
- Don’t make credit applications unless you plan to use them. Applying regularly for credit you don’t use raises red flags for lenders.
Keeping your credit score in good shape…
- Check your report regularly
- Make sure you recognise everything
- Look for inaccuracies
- Report inaccuracies ASAP
Listen to our podcast on how you can be credit healthy
This article was sponsored by Health Professionals Bank.
Membership eligibility and T&Cs apply. Health Professionals Bank is a division of Teachers Mutual Bank Limited. General advice only. ABN 30 087 650 459 AFSL/Australian Credit Licence 238981 | BE03153-0124-ACM