What are different types of credit?

Credit plays a crucial role in the financial lives of many Australians, offering opportunities for major purchases, investments, and financial flexibility. However, not all credit is created equal. In this comprehensive guide, we’ll explore the various types of credit available, their features, and how they can impact your financial health.

The Main Types of Credit

Credit can be broadly categorised into three main types:

Installment Credit
Revolving Credit
Open Credit

Each of these credit types has unique characteristics and serves different financial needs. Let’s delve deeper into each category.

Installment Credit

Installment credit is one of the most common forms of credit. It involves borrowing a fixed amount of money and repaying it in regular installments over a predetermined period.

Key Features of Installment Credit:

Fixed loan amount
Set repayment schedule
Interest charges included in repayments
Typically used for large purchases or specific financial goals

Common Examples of Installment Credit:

Home Loans: Also known as mortgages, these are long-term loans used to purchase residential property. Home loans often come with competitive interest rates and terms of up to 30 years.

Personal Loans: These are unsecured loans that can be used for various purposes, such as debt consolidation, home improvements, or major purchases. Personal loans typically have terms of 1 to 7 years.

Car Loans: Specifically designed for purchasing vehicles, car loans can be secured (using the car as collateral) or unsecured. They usually have terms of 1 to 7 years.

Revolving Credit

Revolving credit provides a credit limit that can be used, repaid, and used again. It offers more flexibility than installment credit but often comes with higher interest rates.

Key Features of Revolving Credit:

Predetermined credit limit
Flexible repayment amounts (above a set minimum)
Interest charged on outstanding balances
Ability to reuse credit as it’s repaid

Common Examples of Revolving Credit:

Credit Cards: These are the most common form of revolving credit. Credit cards allow users to make purchases up to their credit limit and carry balances from month to month, subject to interest charges.

Lines of Credit: Also known as home equity lines of credit, these allow homeowners to borrow against the equity in their property. They’re often used for renovations or investments.

Overdraft Facilities: These are credit facilities attached to transaction accounts, allowing account holders to withdraw more than their account balance up to a set limit.

Open Credit

Open credit, while less common, is still an important type of credit. It requires full payment of the amount owed at the end of each billing cycle.

Key Features of Open Credit:

No preset spending limit
Full balance due each billing cycle
No interest if paid in full and on time
Often used for recurring services

Common Examples of Open Credit:

Utility Bills: Electricity, gas, and water services are typically billed on an open credit basis. Customers use the service and are billed at the end of the cycle for the amount used.

Mobile Phone Plans: Many mobile phone contracts operate on an open credit system, where users are billed monthly for their usage.

Charge Cards: Unlike credit cards, charge cards require the full balance to be paid each month. They’re less common but are offered by some financial institutions

Specialised Types of Credit

In addition to the main categories, there are several specialised credit types designed for specific purposes:

Construction Loans

These are used to finance the building of a new home. Unlike standard home loans, construction loans are typically interest-only during the building phase and funds are released in stages as construction progresses.

Bridging Loans

Bridging loans are short-term loans used when buying a new property before selling an existing one. They’re designed to ‘bridge’ the financial gap between property transactions.

Low-Doc Home Loans

These are mortgage products designed for self-employed individuals or those with non-standard income sources who may struggle to provide traditional proof of income.

Reverse Mortgages

Available to older Australians, reverse mortgages allow homeowners to borrow against their home equity without making repayments while they live in the property.

Choosing the Right Type of Credit

Selecting the appropriate type of credit depends on various factors, including:

Your financial goals
Your income and ability to repay
The purpose of the credit
Your credit score
The total cost of credit (including interest and fees)

It’s crucial to carefully consider these factors and potentially seek professional financial advice before committing to any credit product.

The Impact of Different Types of Credit to your Financial Health

While credit can be a powerful financial tool, it’s important to use it responsibly. Here are some key points to remember:

Credit Score: Your use of credit directly impacts your credit score, which in turn affects your ability to obtain credit in the future and the terms you’re offered.
Interest Costs: Different types of credit come with varying interest rates. Understanding these costs is crucial for effective financial planning.
Debt-to-Income Ratio: Lenders often consider your debt-to-income ratio when assessing credit applications. Maintaining a healthy ratio is important for your overall financial health.
Financial Flexibility: While credit can provide financial flexibility, overreliance on credit can lead to financial stress.

In conclusion, understanding the different types of credit available is crucial for making informed financial decisions. Whether you’re considering a home loan, using a credit card, or setting up utilities for a new home, knowing how each type of credit works can help you manage your finances more effectively and work towards your financial goals.

Remember, responsible use of credit is key to maintaining good financial health. Always borrow within your means, understand the terms of your credit agreements, and seek professional advice from a finance broker if you’re unsure about any aspect of credit or borrowing.