What really happens when you take out credit?

2min read
Posted 16 December 21

Are you thinking about borrowing some money for a mortgage or car loan? Maybe something completely unexpected happened in your life, which requires additional funds? Or are you looking at consolidating (grouping together) all your credit card bills into one manageable loan?

There are many reasons to take out credit when we can't afford the real things we want (or need). But, while it's expected that we enter into a credit arrangement at some point, doing so comes with its risks.

Here, we'll take you through the complete credit journey with its pros and cons. You might want to skip the next few steps if you're just interested in our credit card tips.

How to find a loan.

Googling a loan will bring up many different search options from lenders, credit unions and banks. Most searches should allow you to compare rates based on the purpose of the loan (what you need the money for), the amount you need to borrow, and how long. When lenders look into these reasons, it's sometimes referred to as a quotation enquiry because you're just after a quote at this stage. 

Hot tip play around with the rates you can get and make a note of what each provider offers. You'll then want to work out how well you can budget in the new loan and what sort of hidden terms there are (e.g. late fees and defaults). This is a worst-case scenario, though you shouldn't be planning not to pay.

What type of loan can I get?

Loans come in all shapes and sizes, depending on your goal. Like BNPL (buy now, pay later), some allow you to buy the thing you want immediately. Others, like payday, give you small amounts to tide over with until your next wages. These can be pretty risky, with high-interest rates, so be careful not to get sucked into something you can't afford to meet.

Other loans are more straightforward, like a student, mortgage and home equity (where you borrow based on the increased value of your house). Some are even designed to help you better manage the loan process. Credit-builder loans are relatively low risk because the bank holds onto the money lent to you until you can pay it off collecting interest as you go. Consolidation lets you bundle all your debts to help reduce interest (and the risk of you forgetting about a repayment). 

What else should I know about loans?

Are you going for fixed interest rates? This can be a good idea to keep you locked into an agreed amount, making it challenging to switch payments without incurring fees. Floating loans have the exact opposite problem lots of flexibility, but your interest rate is at the mercy of the market.

Hidden terms.

Some loans are based on collateral, secured against you not paying. If you're going in for a secured loan, you promise an asset (something of value) to be sold off in case of a default. Why would you do that? Generally, secured loans mean less interest because lenders know the money is getting to them one way or another (even if it means selling off something you own, like a car).

That said, if you start defaulting, debt collection agencies will likely begin to reprocess stuff you own anyway to meet repayments. This is generally done with your consent and only for specific items specified by you as collateral.


Credit enquiries.

With this information in mind, you can start making a complete enquiry into applying for credit. Taking out an examination happens a step before the loan or credit card approval, where a credit reporter has a look at all your relevant history. A complete credit application will make your score dip a little, but that's normal. Enquiring into loans doesn't prove you can pay them back you'll need to show a good payment history for that.

How to apply for credit. 

Now it's time to make a complete application. You can do this online or by speaking to a provider directly. When applying for a loan, you'll work out payment methods and bank details, as well as a time to repay it if it's a fixed-term loan. If not, you may continue paying as you go at a specific rate without a set end date. This may be one option for reducing costs in the short run but could mean paying out more interest over time if your loan is open for a while. 

Hot tip If you know you can't ever make a repayment or you missed one, get in contact with your provider and work out a new arrangement. Usually, you can sort it out without it becoming a big issue on your credit history. 

Finishing the credit journey.

Once you've paid your debt in full, you may find that your account is empty. If you're not planning to use the account for anything else, it may pay to close it to avoid having too many open accounts under your name. But before you get to this stage, you might choose to consolidate your little debts into one big account to avoid the hassle of individual repayments. 

Hot tip sometimes, it's best to leave an account open for a while to add more points to your credit score with a good repayment history. So don't feel the need to repay it off all at once to avoid the interest payments that's why lenders agree to a set amount of months in the first place. Your loan is usually worked out on the interest you're paying within a specified time frame, and paying outside of this timeframe may add on additional fees.


In short.

Taking out credit is a bit of a journey, but we recommend making it bottom heavy. Start by researching creditors and working out what you can realistically afford to borrow. Get quotes from credit providers and compare them. If you apply for credit, start a trend of positive repayment behaviour. This is the best way to help your credit score grow and secure better credit in future, should you need it.




Info and tools on the Yonda website are used as a guide only and do not constitute financial advice. Use Yonda as a starting point and then seek professional advice.