The Outliers Circle

On Finances, Demystifying the world of credit – Part 1

Introduction

In today’s complex financial landscape, credit plays a fundamental role in shaping our personal and professional lives. Having a solid understanding of the credit system is essential for making informed financial decisions and managing your financial well-being effectively. Contrary to common misconceptions, it is important and beneficial to establish a credit history in the UK by utilizing credit cards. Your creditworthiness is determined by your past financial behaviour, which means you’ve got to have some credit history. In this article, we will explore the concepts of credit and the credit system to provide you with a comprehensive understanding. Additionally, we will share practical tips, tricks, and examples to help you navigate the world of credit cards and make the most of them.

Credit and the UK credit system

At its core, credit refers to the borrowing capacity extended to individuals, allowing them to obtain funds or goods in the present with the promise of repayment in the future. The concept of credit enables individuals to access resources they may not have readily available, providing financial flexibility and opportunities for growth. In the United Kingdom, the credit system is a comprehensive framework that facilitates lending, borrowing, and financial transactions between individuals, businesses, and financial institutions. It encompasses a range of credit products and services, such as loans, credit cards, mortgages, and overdrafts, which are designed to meet the diverse financial needs of individuals and organizations.

Credit Reference Agencies

To evaluate creditworthiness and assess the risk associated with lending, UK financial institutions rely on information provided by credit reference agencies. These agencies, including Experian, Equifax, and TransUnion (formerly Callcredit), collect and maintain credit-related data on individuals, including their borrowing history, repayment patterns, and credit utilization. The data held by credit reference agencies is used to generate credit scores and reports that assist lenders in making informed decisions regarding credit applications.

Credit Scores and Reports

A crucial component of the credit system is the credit score. A credit score is a numerical representation of an individual’s creditworthiness, reflecting their ability to repay debts and manage credit responsibly. It is calculated based on various factors, including payment history, outstanding debt, credit utilization, length of credit history, and types of credit used. A higher credit score generally indicates a lower credit risk, which can result in better access to credit products with favorable terms and conditions. You can track your credit score and history for free using Experian, ClearScore and Credit Karma.

Importance of Credit

Understanding credit and the credit system is vital for you as an international student or working professional in the UK. It can impact various aspects of your lives, including securing loans for education expenses, renting accommodation, obtaining credit cards, and even future employment prospects. By managing credit responsibly and building a positive credit history, students can enhance their financial prospects and establish a strong foundation for their postgraduate journey. For students who plan to keep living and working in the UK, it’s important to build your credit history which is very relevant in getting a mortgage.

Now, let’s explore the most common types of credit cards in the UK.

Standard Credit Cards

Standard credit cards are the most common type and provide a revolving line of credit that can be used for purchases, balance transfers, and cash advances. These cards typically come with a predetermined credit limit based on the applicant’s creditworthiness. Cardholders have the flexibility to repay the balance in full each month or carry it forward with interest charges. Standard credit cards may also offer additional perks such as reward programs, cashback incentives, or travel benefits.

One specific type of standard credit card worth mentioning is credit building card. These cards are designed for individuals with limited or no credit history, including postgraduate students who are building their credit profile. Credit-building cards provide an opportunity to establish a positive credit history by using the card responsibly and making regular payments. While the credit limits on these cards may be lower and interest rates higher compared to other standard credit cards, they serve as a stepping stone to better credit opportunities in the future. As a personal example, my first credit card was a Capital One Card with a credit limit of £200.

Balance Transfer Cards

Balance transfer cards are designed to help individuals consolidate existing credit card debts by transferring them to a new card with a lower or 0% interest rate for an introductory period. This type of credit card can be beneficial for postgraduate students looking to manage their debt more effectively or save on interest charges. It’s important to note that balance transfer cards often come with a balance transfer fee, and the promotional interest rate is temporary, so it’s crucial to have a plan to repay the debt before the promotional period ends.

Rewards Credit Cards

Rewards credit cards are popular among those who want to earn rewards or loyalty points based on their spending. These cards offer various reward structures, including cashback on purchases, airline miles, hotel points, or retail discounts. Postgraduate students who use their credit cards for everyday expenses can benefit from rewards programs by earning points that can be redeemed for travel, merchandise, or statement credits. It’s important to compare the rewards structure, annual fees, and terms and conditions to find a rewards credit card that aligns with personal spending habits and preferences. Personally, I use the British Airways American Express card which offers Avios points for travel and other perks which I will expand on later in this article. (The free version of the card is available here).

Best Practices and Tips for Using a Credit Card

Using a credit card responsibly is key to managing your finances effectively and building a positive credit history. In this section, we will discuss some best practices and provide valuable tips to help you make the most of your credit card while avoiding common pitfalls.

1. Create a Budget

Before using your credit card, it is crucial to establish a budget. Determine your monthly income and expenses, including fixed costs like rent, utilities, and groceries, as well as discretionary spending on entertainment and dining out. Having a budget in place will help you track your spending, avoid overspending, and ensure that you can comfortably repay your credit card balance each month.

2. Use Credit Card for Everyday Expenses

Another valuable tip is to treat your credit card like a debit card and use it for your daily and routine expenses. Essentially, use it for the expenses you would typically pay with cash or a debit card. This approach helps establish a positive credit history by demonstrating responsible usage. At the end of the day or week, you can review your transactions and pay off the accumulated balance in full. For instance, when buying groceries, commuting by train or bus, or making online purchases, use your credit card. However, it’s crucial to heed the wise advice that my uncle once shared: “Money you don’t have, you don’t spend.” Remember, using your credit card for daily expenses should never exceed your available funds or lead to overspending. It is simply a method to conveniently manage and track your expenses while building your credit history.

3. Pay on Time and in Full

Paying your credit card bill on time is essential. Late payments not only result in late fees but can also negatively impact your credit score. Set up payment reminders or automatic payments to ensure you never miss a due date. Additionally, strive to pay your balance IN FULL each month to avoid accruing interest charges. By doing so, you’ll establish a positive payment history and save money on interest expenses.

4. Keep Credit Utilization Low

Credit utilization refers to the percentage of your available credit that you are currently using. Aim to keep your credit utilization below 30% of your credit limit. For example, if your credit limit is £1,000, try to keep your outstanding balance below £300. Keeping your credit utilization low demonstrates responsible credit management and can positively impact your credit score.

5. Avoid Cash Advances

While credit cards often allow cash advances, it’s generally best to avoid using this feature. Cash advances come with high-interest rates and additional fees, making them an expensive way to access cash. It’s advisable to use your credit card for purchases and pay your bill in full rather than relying on cash advances.

6. Regularly Review Statements

Make it a habit to review your credit card statements regularly. Check for any errors, unauthorized charges, or fraudulent activity. Promptly reporting any discrepancies to your credit card issuer can help resolve issues quickly and protect your financial well-being.

7. Be Selective with Credit Card Applications

Applying for multiple credit cards within a short period can negatively impact your credit score. Each application triggers a hard inquiry on your credit report. Instead, carefully consider your needs and research different credit card options before applying. Choose cards that align with your spending habits, offer desirable rewards or benefits, and have favorable terms and conditions.

8. Monitor Your Credit Score

Regularly monitoring your credit score can provide valuable insights into your credit health. There are various online platforms and credit reference agencies that offer free or paid credit score monitoring services. By keeping track of your credit score, you can identify any changes, detect potential issues, and take proactive steps to maintain or improve your creditworthiness.

Conclusion

In conclusion, understanding the credit system is vital to navigating the financial landscape in the UK. By gaining knowledge about credit, credit scores, and reports, you can make informed decisions that contribute to your financial well-being. Responsible credit card usage plays a significant role in building a strong credit history, unlocking the benefits and conveniences associated with credit cards, and setting the stage for a secure financial future.

In the next part of this article, we will delve deeper into leveraging credit cards to your advantage, focusing on specific aspects such as rewards cards, maximizing travel benefits, booking rewards flights, utilizing credit for mortgage purposes, and exploring borrowing options for business ventures. Additionally, I will share personal anecdotes, helpful links, and valuable tips and tricks for utilizing credit cards effectively, especially when it comes to travel and reaping rewards.

Stay tuned for Part 2, where we will continue our exploration of credit cards as powerful financial tools, helping you make the most of their features and leveraging them to enhance your financial journey. You can also sign to our monthly newsletters here!

By Shola Oladipupo
Photo from Unsplash