To obtain credit is to receive a loan (borrow money) from a financial institution.
Many of us will look to borrow money at some stage during our lifetime. In fact, few people will get through their lives without having to do so.
The reasons you may require credit can vary. Whatever the reason, what is important is how you manage this credit and make your finances work for you.
It is paramount to recognise that although it may be quite easy to get a loan, it can sometimes be a challenge to repay it, so always make sure you can genuinely afford it.
If used wisely, credit cannot only help us reach our financial goals, but also improve our lifestyle.
REASONS FOR BORROWING MONEY
Why does someone decide they need a loan (credit)? Perhaps they are looking to manage their daily life expenses and feel this can be improved with the use of a credit card.
Alternatively, they may be looking to use it for larger purchase like buying their dream home, which would probably otherwise be unattainable without finance.
Borrowing can help you achieve your goals and get there more quickly.
CAN YOU AFFORD TO GET A LOAN?
It can seem like a dream come true. You have found something you really want. You go to the bank and they are willing to lend you the money – amazing! But before you take on a loan or a credit card, you should spend some time reviewing your financial position and make sure that you can actually afford that debt.
The last thing you want to do is be in a position where you spend the money only to find out you cannot afford to pay it back. If getting credit means you are spending money that cannot afford to repay, you could be setting yourself up for financial problems and stress in the future.
To work out if you can afford a loan or whether a credit card limit is manageable, you will need to start by looking at your budget. If you do not have a budget, you will need to create one.
A budget looks at the income going in and the expenses going out. It will allow you to see if there is room for a loan or credit card repayment.
CREATING A BUDGET
Here are a few tips that can help when creating a budget:
• Choose a frequency of weekly, fortnightly or monthly. It is a good idea to make this in line with when you get paid (e.g. Fortnightly pay = Fortnightly budget).
• Round all amounts to the nearest dollar.
For items where the amount changes each time (such as credit card repayments), look at a few recent statements and try to work out an average figure.
Below is a template of many of the things that may be included in a budget. If it seems too difficult for you to work through on your own, give us a call or drop in to your local branch. One of friendly staff would be happy to help you.
INCOME PER W/F/M $
Basic Wage (after tax) ________
Overtime/second Job ________
Investments (e.g. rental income, dividends) ________
Govt Allowances ________
Child Support ________
TOTAL INCOME ________
TOTAL HOUSEHOLD ________
DEBT PAYMENTS $
Car Loan ________
Personal Loan ________
Credit Card Payments ________
Store Card Payments ________
After Pay ________
TOTAL DEBTS ________
FOOD & BEVERAGES $
Eating Out ________
Work day lunch/coffee ________
TOTAL FOOD ________
Council Rates ________
Water Rates ________
TOTAL UTILITIES ________
Car registration ________
Car services ________
Licence renewal ________
Public transport ________
TOTAL CAR/TRANSPORT ________
Health Insurance ________
Life Insurance ________
Home and Contents Insurance ________
Car Insurance ________
TOTAL INSURANCES ________
Entertainment (e.g. movies) ________
Magazines & Books ________
TOTAL PERSONAL ________
School Fees ________
Sport Tuition ________
Creative Tuition (e.g. music & art) ________
TOTAL EDUCATIONAL ________
HEALTH & WELLNESS $
Gym Fees ________
TOTAL HEALTH & WELLNESS ________
OTHER EXPENSES $
Birthday gifts ________
Christmas gifts ________
Pocket Money ________
Child Support Payments ________
Music Services (e. g. Spotify) ________
Pet Expenses ________
TOTAL OTHER EXPENSES ________
General savings ________
Emergency savings ________
Special purpose savings ________
TOTAL SAVINGS ________
TOTAL SPENDING _________
TOTAL INCOME minus TOTAL SPENDING = ________
LOOKING AT YOUR BUDGET OUTCOME
How did your budget look?
If you have money left over, you can probably afford to repay a loan. If your budget shows a negative figure, then your expenses are already greater than your income, and in that case, perhaps it is not the right time to take on any credit.
Make sure if you are currently paying all your bills by credit card that you have enough at the end of each month to pay these out in full. That is the only way using a credit card for bill paying that is efficient. If not, then your spending needs reassessing as you are living above them. Not only is this is not sustainable in the long-term, but you will definitely need to look at cutting back before you think of taking on any more debt.
If it seems like it is not the right time to borrow just now, it is a good idea in the meantime to look at where you can make some reductions in your budget and create a savings plan to start to get your finances working better for you. If you can commit to a regular savings and it is affordable in your budget, it will give you confidence that you would be able to service a loan in the future.
HOW MUCH SHOULD YOU BORROW?
The loan amount should be the amount required for your purchase or goal.
You should ensure that the amount of your loan would make repayments that you are able to service without too much difficulty. Your budget would have given you a good idea, and if it seems affordable then have a credit specialist assess your affordability.
If it is a credit card you are after, then set a suitable credit limit that reflects your ability to repay the full amount available on the card. (As a guide, it is in your advantage to repay credit card debt in full each month to avoid incurring interest charges.)
Never use debt as a source to pay for existing debt.
CHOOSING THE RIGHT LOAN
It is important to find the right loan to meet your circumstances. You want to feel happy and in control on your way to achieving your goal.
Choosing a particular loan depends a lot on your reason for borrowing. Other things to consider or look at when selecting a loan are:
• Will the repayments be within your financial means?
• Will it allow you to reach your goal?
• What is the length of the loan term?
• Is the interest rate competitive?
• What are the fees and charges involved?
• Does the loan require security?
These are a basic type of loan with regular, set repayments and a fixed term (typically up to 5-7 years).
Personal loans are usually taken out with a particular purpose in mind, such as buying a car, financing a holiday or consolidating other debts.
The loan can be either secured or unsecured. ‘Secured’ simply means that an asset (such as a car) is mortgaged as security for repayment of the loan. If you fall behind in the repayments, the lender is entitled to foreclose the asset and sell it to recover their money.
Many people find it easier to keep control of this kind of debt because the repayment amount is fixed (unlike the continuing credit of a credit card). A personal loan is suitable for medium-term borrowing goals and, when used wisely, can help to build your standard of living.
Using a personal loan to consolidate debts can save you money if you pay out debts with higher interest rates and bundle them into one lower interest rate personal loan.
Home loans (Mortgages)
A home loan is the way most people manage to buy their own home. It may also be used to buy a property for investment purposes.
Mortgages are secured by a property and are a long-term (typically thirty years) form of borrowing and the rate of interest charged is usually the lowest of all loans.
The collateral will be held by the lender until the loan is paid out in full.
The interest rate can be fixed (making fixed repayment amounts), variable or a combination of the two. You may decide to pay principal and interest or even select an interest only loan.
Credit cards are a common and popular loan choice. As with all loans, you have a commitment to pay back the money you have borrowed.
With credit cards, you must make a minimum payment each month, which is normally a small percentage of the outstanding balance. Any amount that you do not repay will be carried over to the next month’s bill and you will incur interest charges on that amount. (This is called revolving credit).
Credit cards are ideal to pay for frequent, short-term purchases. They are also handy for making purchases or paying bills over the phone or the Internet.
Used wisely, credit cards have many benefits in terms of convenience and flexibility.
The problem is that it is just as easy to let them get out of control. It can be tempting to make impulse buys that you do not really need or cannot really afford.
Interest free period
One of the great benefits of a credit card is that most offer an ‘interest free’ period, which normally ranges from 44-55 days. During this time, you can repay the amount borrowed (which is the amount of all your purchases) without paying any interest charges. If you are disciplined with your money, the interest free period can really work for you.
However, if you do not repay the amount borrowed in full by the due date, you will incur interest charges.
The interest rate charged on credit cards is normally higher than any other type of loan.
When you withdraw cash from a credit card, it is called a cash advance. In this situation, interest is charged from the day you withdraw the money and the interest rate on cash advances is often higher than the rate you pay on purchases.
It is a very expensive way to obtain cash, so avoid using your credit card for cash advances if possible.
Credit card issuers commonly use a low interest rate as an incentive for you to sign up to their credit card. This balance transfer interest rate applies to an outstanding amount that you transfer from your existing credit card to a new credit card.
It is normally a good deal lower than the interest you are being charged by your existing issuer. However, the lower rate usually only applies for a few months, so it is important to pay off your balance before the interest rate reverts back to the higher rate.
Ideally, once the balance is transferred, you should close the old credit card account. Do not be tempted to spend more money on the old credit card otherwise, you will be left with a debt on two credit cards.
In addition to an annual fee, which is charged each year just to keep the account open, there can be a range of other fees payable. These can include fees for late payments, going over your credit limit, cash advances, over-the-counter payments and overseas transactions.
Ask your credit card issuer what extra fees they charge and then decide if you need these extra facilities.
Being credit card smart
The key to getting the most from your credit card is to use it smartly.
Your monthly credit card statement will outline the ‘outstanding balance’ and the ‘minimum payment’.
The outstanding balance is the total amount owing on your credit card, including any outstanding debt from last month, any interest charges and any new transactions from this month. The minimum repayment is usually a small percentage of the outstanding balance, or a set figure, such as $20, whichever is higher.
You should aim to repay the outstanding balance by the due date whenever possible because you will not be charged any interest. If not, at least try to repay more than the minimum required because this will reduce the interest you have to pay.
Credit card security
Compared to cash, credit cards are a relatively safe way to purchase goods and pay bills in person, over the phone or over the Internet.
However, it is smart to take basic steps to protect yourself against incidents of credit card fraud:
• Memorise your PIN, do not keep a hard copy and never tell your PIN to anyone. It’s also a good habit to change your PIN from time to time.
• Sign your new credit card as soon as you receive it and destroy old cards by cutting them into small pieces.
• Report a lost or stolen card immediately. The card issuer can cancel the card and stop any further transactions being made. This will help ensure you are not held liable for any unauthorised transactions on your card.
• Check your monthly statement carefully. Thieves can make a living by skimming small amounts from lots of people, hoping that it will not be noticed. If you discover charges on your bill that are not yours, notify the card issuer quickly.
• When you hand over your credit card for payment, do not let it out of your sight. It only takes a moment for your personal details to be ‘skimmed’ from your credit card by a dishonest person. Your details can then be used to pay for goods fraudulently. Be alert to this practice, even in reputable stores.
• When using your card for online purchases, ensure the Internet site you are dealing with has high-level security and data encryption to keep your card details safe.
Credit cards and overseas travel
Credit cards are particularly useful when you are travelling overseas. They are widely accepted in most countries around the world, are generally safer than cash and can be replaced quickly if lost or stolen. They can also be used to access cash in local currencies, which can be very convenient.
Credit card transactions made overseas are subject to currency fluctuations and many providers charge an overseas conversion fee, so it is a good idea to keep an eye on exchange rates and review the terms and conditions to be sure what fee you are charged. Normally, the exchange rate that applies is the one current at the time the transaction is made.
APPLYING FOR CREDIT
If you have made the decision to obtain credit, your next step is to contact the financial institution of your choice to get started.
You will most likely be required to complete an application and supply some supporting documentation so the lender can assess your level of risk and decide whether you will be approved for a loan.
Common documents you may be asked to supply for typical loans or credit cards are:
• two most recent payslips
• Rental Ledger/Rates notice (6 months’ worth)
• Bank Statements (3-6 months’ worth)
• Loan, credit card and store card statements (3-6 months’ worth)
For more complex loans like mortgages, you may be asked to supply some additional documentation.
When assessing your loan application, the lender will see if you can afford to repay the loan by looking at things like you income and assets verses your liabilities.
They will also obtain your credit history report to see if based on your history of repaying other loans and debt if you are a good financial risk?
Lenders will be interested in other factors also, such as whether you have a stable employment and residence history. This will be used to build a credit profile.
Your Credit File
Before approving a loan, responsible lenders will check your credit file, which has been built up over time and stays on your file for at least five years.
If you have ever borrowed or applied to borrow money, you will have a credit file. Your credit file includes:
• Your personal details - name, date of birth, drivers licence number, current and past residential addresses.
• Records of applications you have made for credit and current credit sources.
• Reports by credit providers regarding defaults, seriously overdue accounts (more than 60 days late) and those that have been brought up to date.
• Items on public record such as bankruptcies and some court judgments.
• Details of company directorships.
PROTECTING YOURSELF AGAINST FINANCIAL STRESS
People can experience financial difficulty due to a number of reasons. Perhaps by borrowing more money than they could really afford, receiving unexpected bills, having health problems that stop you from working or dealing with all of these things at once.
Individually, you may normally be able to cope with each emergency. However, when they all happen on top of each other, it is easy for the situation to get out of control.
Different people handle financial pressure in different ways, and, as a result, the consequences vary too. Some of us don’t have the skills to handle a difficult financial situation or simply ignore the warning signs, which can result in a serious financial crisis.
The best protection against financial crisis is a solid budget and reasonable savings, which you can rely on when needed. It is also important to be alert to early warning signs.
Aim to have the equivalent of 3 months take-home salary set aside for emergencies and unexpected expenses.
You never know when financial stress might happen.
WHAT TO DO IF PROBLEMS ARISE
If you are experiencing financial stress, the best thing you can do is take action.
If you do nothing, the problems are not going to go away and, in fact, they will probably get worse.
So, the first thing to do is to acknowledge that you are having difficulties and decide to take control.
You may feel anxious or embarrassed talking about financial stress, but it is important to let your creditors know what is happening. You could possibly save yourself stress and money by taking control and acting on your situation sooner rather than later. Most creditors will be pleased that you have made an effort to keep them up to date.
If you do not return their phone calls or acknowledge their letters, they will assume the worst and it will put them offside. However, if you are honest about your situation of hardship and explain logically how you can realistically repay your debt, you may find your creditors are sympathetic to your circumstances and willing to help. From their point of view, they are more likely to get the loan repaid in full if they help you through a hard patch.
Consolidate your debts
Sometimes a way of managing the repayment of your debts is to consolidate them into one loan. You can use a personal loan to consolidate debts, which can save you money by reducing the interest rate you are paying and lower your overall repayments to a manageable level.
You may also like to consider reducing your level of credit, such as reducing the credit limit on your credit card, so that you are not tempted to let your debt get out of control.
If things get really tough, you have to opportunity of settling most debts without needing to go bankrupt. You can negotiate a Debt Agreement with your creditors.
This is an agreement made mutually between yourself and your financial institution, which is legally binding.
Debt Agreements are designed for people with some ability to repay their debts and must be able to offer creditors some return on the debts.
Court instalment orders
If you have not been making repayments and are hard to contact, your creditors may refer your debt to the courts and you will receive a court Statement of Claim.
Even if you have already received a Statement of Claim, it is not too late to talk to your creditors. Although you must still follow the timetable set out in the Statement of Claim to lodge a formal defence, or your creditor can seek a default judgment against you. If you make contact with them, they may still be willing to make arrangements for you to repay your debt.
If your creditors are not willing to make a repayment arrangement, you can go to the court, talk to the registrar and apply to pay the debt by instalments through the court.
When your debts reach a level of seriousness that the courts get involved, you have little say in what happens next. That is why it is so important to take control of your situation as soon as you start experiencing financial stress. Talk to your creditors and together you can implement a repayment plan that works for both parties.
Once bankruptcy is registered this clears all debts and claims against you.
When your creditors are in regular contact, urging you for payment, and your situation is getting more stressful, bankruptcy might like an attractive option. However, this short-term fix can have some long-term disadvantages.
Bankruptcy should be avoided and only used as a last resort, as once you go bankrupt, there is no going back and the consequences are extensive.
Always seek advice from a finance professional before taking the bankruptcy path. If you are prepared to work through your financial difficulties, most people who seek the help of a financial counsellor can avoid bankruptcy.
If you declare bankruptcy, you are recorded in a public record as a person who is unable to meet their financial obligations. Some of the other things that could happen are:
• Losing control of your assets and items of value.
• If you own a house or are paying one off, the bankruptcy trustee can sell your property to repay your creditors.
• If you do not own your own home, it will be very difficult for you to rent while bankrupt.
Landlords are unlikely to agree to a lease with a person who is bankrupt. Even after discharge, it is likely to be hard.
• You may even find it difficult to get electricity, water or a phone line connected without paying a sizeable bond.
• If you earn an income, you are obliged to make regular repayments to your bankruptcy trustee for the benefit of your creditors. The amount you are required to pay varies according to the number of dependents you have.
• Bankruptcy may affect your employment. Certain trades and professional occupations are subject to restrictions imposed by licensing authorities or professional associations.
If you file for bankruptcy, you may lose your job, or it may affect your future prospects in your chosen field.
• Any money or assets you inherit from a deceased relative or friend also goes to your bankruptcy trustee, to be sold for the benefit of creditors.
• Borrowing money will be very difficult. The bankruptcy listing will stay on your credit file for 7 years, making it almost impossible for you to borrow money.
• If you want to travel overseas, you must get written approval from your bankruptcy trustee or permission from the court, depending on the circumstances of your bankruptcy.
WE ARE HERE TO HELP
At Australian Mutual Bank, we are ready to help you!
Take a look at our range of loan products and credit cards, which offer competitive loan rates and generous features, and speak to one of our knowledgeable and friendly team of Credit Specialists.
If you are looking for a Financial Planner, we can organise that for you also. (Did you know all our members receive their first visit with a Financial Planner free of charge?)
Call us on 13 61 91