Different Types of Credit Explained
These days there are so many different forms of credit available, it can be a minefield trying to work out which is the best option. Each has its pros and cons but its suitability varies depending on the individual. Here’s a brief roundup of some of the common types and how they work.
The most popular form of credit in the UK. Credit cards are accepted almost everywhere and offer a variety of interest rates and credit limits which are usually set depending on a person’s credit score. Repayments to the card are due each month, either to clear the balance or to meet the minimum repayment. Lender’s often offer incentives for people to apply and spend on their cards such as interest-free periods, air miles or free gifts.
Personal (unsecured loans)
One of the most common types of loan, personal loans are typically borrowed from a bank and are usually for larger amounts than that of a credit card. Their interest rates vary hugely from one lender to the next and the rate offered is based solely on the individual’s credit score. This means that those with thin or poor credit history might be offered a higher interest rate or be refused credit altogether.
This type of loan is usually aimed at those who have had difficulty obtaining credit elsewhere. The loan is backed by friend or family member; a guarantor who is willing and able to cover the repayments should the borrower not be able to. Because of the increased risk, the interest rates are typically higher than other forms of credit, however, those with lower credit scores are more likely to be accepted.
Similar to credit cards, store cards are a form of credit usually limited to a specific store or group. They tend to carry a higher interest rate than a credit card but commonly offer ‘rewards’ such as discounts, free gifts or ‘buy now pay later’ deals for purchases within their store.
These are loans taken for the sole purpose of starting a new business or expanding an existing one. Due to the nature of the loan, the amounts and repayment periods tend to be much larger than those of personal loans but are often only available to VAT registered companies.
Overdrafts are designed to act as an extension to a current account and help to prevent any payments being rejected due to insufficient funds. Historically charges for using an overdraft were a daily or monthly fee, however recent changes mean that they must now be charged as an APR, the same as any other type of credit. If the account is in a negative balance, any payments made into the account will automatically be used to clear this first.
These type of loans are secured against an asset the belonging to the borrower such as property or a vehicle. They usually offer a lower rate of interest but the risk of losing their possession is often enough to ensure the borrower keeps up with repayments. In the event of non-payment, the lender is able to sell the asset in order to recover their losses.
Commonly advertised as a quick cash option. Payday loans offer a small amount of cash for a short period of time, usually up to a month, or until the next payday. These loans carry very high-interest rates compared to other types of credit however these are now capped so a person never pays back more than 100% of the amount borrowed.
An older type of credit mainly used for the purchase of clothing via a catalogue. Companies tend to advertise this as a ‘buy now, pay later’ option, allowing people to spread the cost over a certain timeframe. These carry a similar interest rate to store cards, though many companies offer an interest-free period as an incentive to purchase.
This type of credit is advertised as a way to spread the cost of a new vehicle purchase as an alternative to a personal loan. The most common form is hire purchase (HP) which, after paying a deposit the remainder of the vehicle’s value is spread into monthly repayments until it is fully repaid. The other, less common option is personal contract purchase (PCP) which offers lower monthly repayments as the amount borrowed is not for the full value of the vehicle. At the end of the repayment period, the borrower can choose to trade the vehicle in for a different one or make an optional final payment if they want to own the car outright.
Taking out any form of credit can be a risk, so it is always recommended that independent legal advice is sought out before committing to anything
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