What is credit?
When you buy something on credit, you take possession of your purchase now and pay for it in the future. At its heart, credit is based on trust – the lender trusts your ability and intent to pay. Your credit history shows how you’ve handled credit in the past, and suggests how well lenders can trust your ability and intent to pay in the future.
Credit allows you to buy something such as a new washer, a car or even a house, while promising to pay for it from future earnings. Credit can also give you access to cash in an emergency, and enable you to consolidate debt to better manage your finances.
Should you use credit?
There is no simple answer. Every time the question is raised, you will have to decide whether buying an item on credit is worth the additional cost.
Some factors to consider when using credit:
- Do you need the item now or can you save for it?
- Do you have savings or cash you might use instead?
- How much will the interest and other charges be?
- Do these payments and costs fit into your budget?
- How much will this purchase increase your total debt?
Pros and cons of using credit
Credit can smooth your finances and improve your standard of living. However, if not used carefully, credit can put you dangerously into debt. Remember; credit is only a substitute for cash. It must be paid back – with interest.
Listed below are some advantages and disadvantages of using credit.
| Advantages | Further information |
|---|---|
| Immediate use of goods and services | Get it now, pay later. This is especially helpful for big value items such as a piece of furniture, a car, or a house. |
| Shopping convenience | Credit cards and charge cards allow you to shop and travel without carrying large amounts of cash. They also provide monthly records of your spending. |
| Reservation and purchases by phone or online | Credit cards and charge cards make it possible to reserve rental cars and hotel rooms, or buy tickets or other merchandise over the phone or online. |
| Emergency cash | Credit cards provide a temporary solution to unexpected financial difficulties. |
| Advantages | Immediate use of goods and services |
|---|---|
| Further information | Get it now, pay later. This is especially helpful for big value items such as a piece of furniture, a car, or a house. |
| Advantages | Shopping convenience |
| Further information | Credit cards and charge cards allow you to shop and travel without carrying large amounts of cash. They also provide monthly records of your spending. |
| Advantages | Reservation and purchases by phone or online |
| Further information | Credit cards and charge cards make it possible to reserve rental cars and hotel rooms, or buy tickets or other merchandise over the phone or online. |
| Advantages | Emergency cash |
| Further information | Credit cards provide a temporary solution to unexpected financial difficulties. |
| Disadvantages | Further information |
|---|---|
| It costs money | Purchases paid for over time cost more, often much more than cash. That "irresistible bargain" may not be a good deal when you add in the cost of credit. |
| It tempts overspending | Credit makes impulse buying easy. Some consumers go deeply into debt buying items they don't really need and can't really afford. |
| It ties up future income | Credit purchases mean you will have to pay for the item, plus interest in the future. This means less available cash in the future. |
| It may result in losses | If you fail to make payments on time, you may lose the merchandise. For loans that require collateral, you could lose valuable property, or even your home. |
| Disadvantages | It costs money |
|---|---|
| Further information | Purchases paid for over time cost more, often much more than cash. That "irresistible bargain" may not be a good deal when you add in the cost of credit. |
| Disadvantages | It tempts overspending |
| Further information | Credit makes impulse buying easy. Some consumers go deeply into debt buying items they don't really need and can't really afford. |
| Disadvantages | It ties up future income |
| Further information | Credit purchases mean you will have to pay for the item, plus interest in the future. This means less available cash in the future. |
| Disadvantages | It may result in losses |
| Further information | If you fail to make payments on time, you may lose the merchandise. For loans that require collateral, you could lose valuable property, or even your home. |
Understanding credit cards
Credit cards allow you to make purchases up to certain credit limits. Your balance (the total amount you owe on the card) may not exceed that limit. You will be billed every month, and at that time you must pay at least the minimum payment highlighted on your bill. However, you always have the option of paying more than the minimum, or even the entire balance, without a prepayment penalty.
It is best to pay off as much of the balance as you can because credit card companies bill you monthly and impose a finance charge on the unpaid balance. Interest rates and fees vary widely, and there is often an annual fee. You can also get cash advances on most major credit cards by presenting them at any bank or ATM that honours them. Many major credit cards also offer 24-hours customer service over the phone or Internet.
Your monthly statement is an excellent source of information about your credit card account.
Your credit card statement is a summary of your account at the end of each statement period. It shows what you owed at the start of the billing period, what you owe now, and every charge and payment that you made during the period.
Though the statement isn't designed to help you evaluate your spending habits, you can use it for that purpose. If you're trying to find ways to cut expenses or set aside more for investment, you can track money you're spending on optional items. Instead of spending all of it, you might consider putting a portion of the money into investments or savings.
All statements contain virtually the same information. If you know what the terms mean and how they affect what you can spend and what you will pay, you can use credit wisely. Some of the terms are as follows:
- Statement balance is the amount you owed on the day the statement was prepared. It includes any finance charges and late fees
- Credit limit is the amount of credit you can use
- Previous statement balance is what you owed on the day your previous statement was prepared
- Minimum payment due is what you must pay. Typically you are required to pay 5% of the new balance or RM50, whichever is greater. Whatever is in excess of the minimum payment due and is not paid will be carried forward and subject to finance charges.
- Payment due date is the last day your payment can be received to avoid additional finance charges or late payment charges
- Cash advance is money you can withdraw with your credit card. You need a personal identification number (PIN) to use an ATM.
- Statement date is the date the statement was prepared. Any charges to your credit card after this date will appear on the next statement.
- Finance charge is the interest charged on the outstanding balance after the payment due date
- Transaction details are records of the purchases and cash withdrawals you made, giving dates and details for each. Check these details against your records to be sure that the charges are all yours.
- Late payment charge is the charge imposed if you fail to make the minimum monthly repayment by the due date
Types of credit cards
People today are faced with many choices when it comes to using credit. The following types of credit are most commonly used.
Charge cards
With charge cards, you pay your bill in full each month rather than carry a balance.
Credit cards
Unlike charge cards, credit cards allow you to carry a balance from month to month. However, you are required to make at least a minimum payment each month. Interest is charged on the outstanding balance. Major credit cards carrying the Visa® and Mastercard™ brands are honoured by merchants around the world.
Debit cards
With debit cards, the full amount of the purchase is immediately deducted from your current/savings account at the time of use.
Choosing the right credit card
In shopping for credit cards, you’ll want to consider three factors. They can help you determine which card to use, because they can help you save money. Below are some factors you need to consider.
Annual fees
Annual fees are once-yearly charges for using a particular card.
Finance charges
Finance charges are the costs of using credit card. Many credit card issuers charge 18% or more a year on your outstanding balances and cash advances. However, some banks charge less, sometimes significantly less during an introductory period. If you regularly have an outstanding balance, it can be wise to shop for the lowest rate.
Interest free period
You will enjoy a 20-days interest free from the date you are billed for all retail transactions (except cash advances and balance transfers).
Cash or credit?
Saving your money and paying cash for an item is less expensive than using credit. But credit gets you goods and services now. Both require that you regularly set aside money from current income. In other words, if you cannot afford to save for it, you cannot afford to buy it on credit.