Credit is money provided as a loan by a financial institution, such as a bank or credit union. It’s a vital tool that can help you to acquire assets on the journey to financial independence.
Here are some credit products you may know:
Consumer Loan
A consumer loan is a sum of money that a creditor or lender (e.g., bank, credit union) loans to a borrower to use for purchasing goods.
Investment Loan
An investment loan is used for starting or improving a business. It can also be used to acquire other assets such as real estate or securities with the expectation that the returns will be greater than the loan with all its associated costs.
Home Loan
A home loan is provided for the purpose of purchasing a house or land for residential purposes, or to conduct home improvement projects.
Credit Card
A credit card is an instrument that provides access to a set sum of money via a secure card that can be used like cash to make purchases at merchants that have the relevant facilities to accept it. A credit card can also be used to access hard cash from an automated teller machine (ATM). However, monies accessed from a credit card, like a loan, must be repaid within a stipulated timeframe or it will attract interest. The credit card holder must repay the monies used, plus interest, if necessary, to continually have access to funds on the card.
Benefits of credit include:
- It allows you to make large cash investments and purchases which you would not normally be able to afford if you had to pay from your pocket
- Helps the borrower to develop a credit history, also known as financial footprint, which is simply a documented pattern of how well one repays what they borrow or finances their obligations, such as bills. A good credit history can help you to receive a larger loan at the best rate possible.
Use credit to make that business idea a reality.
Advice when Accessing & Using Credit:
- Payments should not exceed 50% of your gross monthly income (total monthly before income tax)
- Read and fully understand all loan contracts before signing
- Make timely and full monthly payments to avoid late fees and interest
- Report your credit card if it is lost or stolen
- Borrow to acquire assets which will increase in value or generate income
An important Difference
- A credit card is a tool for spending money that is loaned to you
- A debit card is a tool for spending your own money
The Five ‘Cs’ of Credit
Before a bank or other lenders provide a loan, there are five characteristics they’ll look for in each borrower before making a decision.
Character
Institutions can make a judgement call about a person’s or business’ reputation based on their credit history. One’s credit history is simply a documented pattern of how well they repay what they borrow or finance their obligations, such as bills. From one’s pattern of repayment, an institution can determine a borrower’s ‘credit worthiness,’ which means whether someone is likely to honour their commitment to repay.
Credit histories are maintained by a credit bureau. Jamaica currently has three credit bureaus.
Capacity
Financial institutions will assess a person’s or business’ income and liabilities to determine whether they can afford the loan they’re applying for. The final outcome is the total debt service ratio, which is a comparison of your total debt to your gross income (income before deductions). If your debt exceeds 50 per cent, the institution will likely consider you a risky borrower.
Capital
When talking about loans, capital refers to how much the borrow has to invest or put towards the purpose of the loan. Lenders often take this into consideration. Having some amount of savings or monies set aside, is an indication that the borrower is serious and committed to the investment, and that there is a pool of funds available to service the loan if issues arise later during repayment.
Collateral
To protect their interest, institutions often require security, or what’s known as collateral, for a loan. That is any asset that can be easily sold or converted into cash by the lender if the borrower is unable to repay their debt.
Conditions
Every loan comes with certain conditions or terms attached. Primarily these include the interest rate, the tenure of the loan (length of time for which the money is borrowed), as well as other conditions the lender may wish to impose, for example, the method of payment, which could be via salary deduction, standing order, or any other method.
The terms of your loan may also be tied to existing economic conditions at the time of the application, which may have some bearing on some elements, such changes to your interest rate and fees charged.