For better or for worse, the credit economy is here to stay; at least for the foreseeable future. The debate between using cash or credit isn’t a new one, and both have their well-documented strengths and weaknesses. The trick is, to know when to use each to your advantage. If you have to be part of the system, you might as well make it work for you!
The great thing about cash (and it’s the way I think about it), is that you either have it, or you don’t. No messing around, repayment plans, interest rates, or late fees. You earn it, you spend it, and you go and earn some more. The simple life!
Living your daily life using cash can be a great way to develop discipline in your spending habits. It goes hand in hand with learning to budget. You can’t spend what you don’t have, so you learn to be careful how you spend and regulate your cash flow so that you never find yourself stuck without finances. There’s also something about physically seeing the money in your bank account diminish that helps you understand the value of a pound.
However (and here’s the big ‘but’), credit is an unavoidable part of society. Without a credit history, you will find it nearly impossible to buy or enter into big contracts, such as buying a house. It’s a way of spending money that you can’t avoid; so you need to learn to understand it.
Credit cards are probably the most prevalent way of borrowing money currently. Because of this (depending on your credit history!) you can really afford to shop around to get the best deals.
We all know the drill; only borrow what you can afford to pay back, always pay off your credit card each month to avoid paying interest on the money you borrowed, and always pay on time or you’ll be charged.
But what does all this actually mean?
Let’s start with the basics: APR. This little acronym will follow you around your whole life so you may as well get on board with it. APR stands for Annual Percentage Rate. This is the yearly payment that you will have to make just for the privilege of borrowing money. You will see this on any loan or credit card, and it’s the ‘extra’ that you will need to pay on top of the sum that you actually borrowed.
In practical terms, this means that if you borrowed £100 at 10% APR for a year, you would at the end of the year have actually paid back £110.
Credits cards give you a month grace period from when you borrow the money, to when you need to pay it back. Each bank will set up a different payment date when you set up the credit card. Be sure to note this date and never miss it. Late fees are unforgiving and even if the money reaches their account one minute after midnight you will be charged a fee for late payment. Not only can these fees be hefty, but they also count as a black mark on your credit history. The more black marks on your credit history, the harder it can be to obtain a loan, take out a mortgage, or even rent a car.
The best way to use a credit card is for small spends that you know you can afford to pay back within the one month period. This is important because if you spend more than you can afford to pay back the next month then two things will happen:
- firstly, you will not be able to pay back the lump sum and so you will be caught paying interest on the money you borrowed (the APR)
- and secondly, this could lead to a spiralling of debt. The more the money rises with added interest each month, the less likely you are to be able to pay it back, and so the amount will continue to grow month on month.
If you shop around you will find that some companies will offer a tantalising "0% interest for your fist year". This is actually a great deal. It means that if you borrow £100 on your card and pay it back within the year, then you will only pay back £100. No extra costs and no interest payments added each month. Beware though, you will still have to pay the minimum monthly payment on the amount you borrow or you will be charged.
This can be a great way to pay off big costs like a holiday. If you know that you can count on income coming in each month in order to help you pay back the entire sum over the whole year, then it’s a good way to borrow money without paying interest on it. But watch out, once the year is up the APR will rise. Don’t let this catch you out. I recommend having a clear balance by the end of the year, and then cutting up the card and closing the account. Then begin the process again for looking around for a new credit card with a better interest rate.
I know it sounds like a lot of work, but it’s the best way to play the credit system. You won’t be paying any interest on the cash that you’ve borrowed, you will be able to afford big one off spends and pay them back at a reasonable rate with no penalties, and at the same time you will be building up a good credit history. Basically; always read the small print, and try to just use your common sense. Don’t borrow more than you can afford, and always pay back what you borrow.