Understanding Credit: Benefits and Pitfalls Explained in Detail

Credit - Your Friend or Foe?

Is credit your friend or foe when buying items like sunglasses or earrings?

The information on this website is general in nature and does not take into account your objectives, financial situation, or needs. Consider seeking personal advice from a licensed adviser before acting on any information.

In this article, we investigate the difference between money and credit. When either will buy those wicked sunnies or cute earrings, the difference can start to become more than a little blurry.

Often when people use credit, they know they’re paying with money they don’t have, but they fail to appreciate the interest and just how long they might be nursing it …. months on end, maybe even years.

Interest

Say you buy those earrings and you choose only to pay the interest payable on your credit card, rather than paying the balance back by the due date… then you might end up buying those earrings a couple of times over, depending on how long you carry your balance without attending to it.

If you didn’t buy it on credit, you could have purchased something else with that interest… or you could have paid another debt off or maybe even kept some money aside so you were prepared for contingencies.

Can you see what we’re trying to get at here?

At the end of the day, it’s not your money, and you have to pay that money back… with interest.

Interest is the price of the money used over the given period of time, depending on the risk profile of the person receiving the credit, any security involved and the use of the credit.

Good credit

But credit isn’t always bad either. Even consumer credit.

Access to credit can help smooth out your entire well being and lifestyle.

If you didn’t have access to credit and the unexpected occurred or you budgeted poorly, you’d have to grind it out until the situation improved, surviving on rice and tomato sauce whilst not paying any bills or accommodation.

You wouldn’t be able to buy desired things when they came up or take a holiday for a few days even if you hadn’t quite saved up for it.

You probably couldn’t purchase a car or even dream of buying a house by writing out one big cheque for a few hundred grand.

Weighing up the costs

Essentially, in these cases, you weigh up the cost of paying the price of the item, plus the much larger associated finance cost.

You contemplate having the item now, against not having and perhaps never having it…and generally you go ahead with the transaction.

Wealth creation

Credit facilitates the creation of wealth.

We can borrow to enjoy the leverage of appreciating assets with greater returns than the interest paid.

These returns can create more options and equity, which can be secured by credit providers to borrow even more funds and acquire more assets.

In the meanwhile, our own funds, not credit, should be used for the purchase of depreciating consumer items or we risk never having the opportunity to build wealth.

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Published: Tuesday, 3rd Aug 2021
Author: 46

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Knowledgebase

Margin Call:
A demand by a broker that an investor deposit additional money or securities into the account to cover possible losses.