If you’ve ever applied for credit you’ll know it’s a bit of a process. You might feel like you’re being scrutinised and in some instances, you are!
Are you worth it?
Before credit gets approved, the credit provider will want to know if you’ll be able pay back what you owe. They look at more than just your affordability – what you can afford to pay each month. They need to know if you can be trusted to pay your debts on time. This is called your creditworthiness and they base it on how well you’ve managed your debt payments in the past.
This is the reason why your credit record plays such a big role in whether or not you can get credit. It gives a history of your credit behaviour. Your credit behaviour is reported to the credit bureaus by your previous credit providers and is available for credit providers to scrutinise during your credit application process. Things like missed payments, defaulted accounts (accounts more than 3 months in arrears), credit-related court judgements and previously-rejected credit applications, among a number of other issues, all negatively affect your credit record.
There’s always some risk involved in lending money and since it’s the credit provider that’s taking this risk it’s understandable that they’re going to do their homework before making a decision. Your creditworthiness helps them to decide on whether or not to give you credit as well as the interest rate they’re prepared to give you on your loan or finance agreement.
Highs and Lows
Interest is affected by how risky the loan is for the credit provider – the higher the risk, the higher the interest is likely to be. Many factors can influence risk, for example, if you’re a first-time customer, you’re seen as riskier than someone who has already proven they can pay back a loan.
Another factor that influences interest rates is whether or not the credit is secured. When a loan is secured, there’s collateral (like a house or a vehicle) behind it, meaning the lender won’t lose all their money if you fail to pay them back.
For example, a home loan is secured because the house acts as its own ‘security’. If you stop paying your home loan, eventually your house can be handed back to the bank and they can sell it to recover the money you still owe them. This means there’s less risk for the credit provider and the interest rate is usually lower.
On the other hand, unsecured loans – such as personal loans – usually come with higher interest than secured loans because there’s nothing tangible for the credit provider to use as security if you’ve spent the money and can’t pay back the loan.
Control what you can
There’s not much you can do about the difference in interest for secured and unsecured credit – that depends on the type of loan you need. However, by managing your current debt and accounts responsibly you’re building your creditworthiness. This can help you to get future credit applications approved and potentially positively influence your interest rate.
Knowledge helps you to do the best you can with what you’ve got so you can have some influence over future outcomes. #LearnSomethingNew every day!