Comparing credit options

Buying on credit has become commonplace today, with people finding it easier on their wallet to pay for major purchases at a later date and opting to make online purchases. However, the array of credit options out there makes it very difficult to choose what form of credit they should sign up for, as well as the advantages and disadvantages of each. Here, illion explains four credit options and what to watch out for.

Credit cards

Pros - Credit cards are the most popular option and are relatively easy to apply for, even if you have little credit history. Credit cards are very convenient as you can use them to make online and phone purchases, as well as use them abroad, which can be useful if you need to pay for unexpected costs or major items. This also reduces the need to carry as much cash around, and also means you don't have to pay for your purchases straightaway (most banks give you 44-55 interest-free days to pay off the credit balance). The cost of obtaining a credit card is also relatively low (or you can opt for one with no annual fee).

Cons - Despite all its benefits, a credit card can be dangerous for people who are unable to manage their spending or pay their bills. It's all too easy to swipe the credit card without thinking about if you can afford to pay for your purchases and if left unheeded, can result in mounting debts.

What should I do ? It's a good idea to assess your spending habits, needs and financial position before getting a credit card. For instance, if you're earning a steady income and require a card to pay for everyday expenses but don't need any rewards, a basic, no annual fee card may be the best option. On the other hand, if you are a high-income earner who often makes overseas trips, you may want to consider a frequent flyer rewards card.

Personal loans

Personal loans from the bank or a financial institution can either be secured or unsecured. Secured or fixed rate loans are 'backed' by a security asset such as a car or house, which means that if you are unable to make repayments, your lender may repossess the asset to cover outstanding balances. Unsecured or variable rate loans aren't backed by anything, but if you can't make repayments, this may show up as a default on your credit report, which could reduce your chances of applying for credit in the future.

Pros - Secured loans usually have lower interest rates than unsecured loans and credit cards, and there is usually no limit on how much you can borrow. While this can be dangerous (see below), it also means that you will know how much you're paying for during the life of the loan because the interest rate is fixed. The loan term can range from one to five years, so you can pay it off quickly or spread it out depending on your finances.

An unsecured loan, on the other hand, has a loan term of one to seven years, and you are not required to provide security. This can be advantageous if you are able to make the weekly, fortnightly or monthly repayment. Additionally, it has a variable interest rate so you may be able to benefit from interest rate cuts.

Cons - As with any form of credit, there are disadvantages, the first being that if you're unable to make your payments, there are dire consequences (more so than a credit card, where you're only obliged to pay the minimum amount each month). Furthermore, there are loan approval and administration fees, which you may be able to avoid with a credit card.

What should I do? Evaluate your need to take out a personal loan, as it's not something you apply for to pay for everyday expenses. Typically, people take out loans to go on holiday, purchase a car, pay for home renovations or a wedding, or consolidate debt. Consider if the interest you pay on the loan is worth it in the long run, particularly if the loan is for something you could save up towards.

Interest-free deal

Pros - Interest-free deals are offered in stores that allow you to take your purchases home before you pay for them, either by signing up for instalment payments or by making a deposit. This generally applies to white goods, computers and other major household goods. You may be able to enjoy your purchase immediately but there are many things you need to look out for, according to Consumer NZ.

Cons - If you do not repay the total amount of your purchase within the interest-free period, you're liable for an extremely high interest rate, which could range up to 30 per cent. Your credit provider is under no obligation to remind you when this period ends, so you will have to watch out for this yourself. Your total payments could also include a monthly service fee or establishment fee.

What should I do? Firstly, consider if you really need to make the purchase and research all possible avenues - it may be worth it saving up for the item. But if you decide to go down the interest-free route, make sure you read all the terms and conditions before signing, as you may not be able to make extra payments beyond those agreed in your contract. Calculate the monthly repayment for yourself instead of leaving it up to the credit provider to determine if you can actually afford it.

Credit options are different for each person according to his/her need, so ensure that you choose the one that's right for you instead of rushing into an impulse decision.

Next week's article will focus on the types of credit cards available and what to watch out for.