What is credit?

What is credit and how does it work?

In a nutshell

Simply put, credit gives you access to money now and you agree to pay it back over time, usually with interest. 

Credit can be useful if you’re planning a large purchase or as a way to consolidate existing debts.  

How much it costs you to borrow money depends on a number of things, including how much you borrow, how long it will take to repay and the terms of your credit agreement. 

Go to:

How credit works
Different types of credit
Where can you get credit
The difference between secured and unsecured borrowing
5 ways to manage credit

How credit works 

Different credit products work in different ways. But it can be useful to know the following: 

 

Interest rates

The amount of interest you’ll pay is usually worked out as a percentage of the money you borrow. The higher the percentage of interest, the more it will cost to borrow.

Credit limits

A credit limit is an agreed amount that you can borrow up to. You’ll usually find you have a credit limit on things like store cards, arranged overdrafts and credit cards. Going over a credit limit could mean being charged additional fees, and it could also impact your credit score.

Regular payments

The most common way to repay credit is with monthly payments. Making your payments on time is important to avoid extra fees and charges. Late payments could impact on your ability to borrow in the future. All the terms and conditions around what and when you pay should be in your credit agreement.

Other borrowing costs

There may be other fees and costs associated with borrowing, as well as the interest rate. There may be annual fees, charges for late or missed payments. Some credit cards, for example, may charge if you withdraw cash or spend abroad.

Different types of credit 

Here are some of the most common types of credit: 

Mortgage

A mortgage is a loan for buying property. These are typically long-term loans that are secured against the property. That’s why if you don’t keep up your repayments on a mortgage, you could lose the property. Mortgages can be offered on fixed or variable rates, and usually need a deposit which will be a percentage of the amount you are buying the property for. 

Two kinds of mortgage you may see: 

  • A repayment mortgage: You’ll be paying back both interest and the capital in agreed monthly instalments over a term. It’s common to pay more towards the interest rate at the start, and less as you reduce the balance.
  • An interest-only mortgage: Monthly repayments to pay only the interest and not the capital. This may mean that the repayments are lower than a repayment mortgage. Remember, you’re not paying off the capital and this would need to be repaid in full at the end of the term.

Car finance

You can take out credit specifically to pay for a car. There are different car finance options to choose from, such as:  

  • Hire Purchase (HP): Fixed monthly payments over an agreed amount of time. At the end of the agreement, you’ll own the car. 
  • Personal Contract Purchase (PCP): Usually offering lower monthly repayments over a shorter term, and at the end of the term you have the choice to return the car, or buy it with a final lump sum. 

Credit card

A credit card can help to spread the cost of purchases over time or can be used to consolidate existing credit card balances using a balance transfer. 

Most credit cards can be used for everyday spending in shops, online and provide access to cash at compatible cash machines around the world. There are many different kinds of credit cards with different rates of interest, associated costs and fees, and different terms of agreement.  

Personal loan

A personal loan can be a steady and predictable way to borrow money. It’s a loan of a fixed amount over an agreed period of time. Monthly repayments could be on a fixed or variable rate. As long as payments are made on time, the loan, including any interest, will have been paid back in full when the term ends.

Overdraft

An overdraft is credit that is linked to a current account. An arranged overdraft can be used as a short-term safety net to cover unexpected costs. Managing your arranged overdraft well includes staying within your arranged overdraft limits.

Some current accounts may allow you to go over an arranged overdraft. This is called using your unarranged overdraft, and is likely to affect your credit score.

Store card or store credit

Some retailers offer the option to buy now and spread the cost over time with their own store cards or store credit. This kind of credit is limited to a store or brand. As with any borrowing, you’ll need to make regular payments on time, and there could be other costs and fees.    

Don’t get confused between a loyalty card and a store card. A store card is credit, while a loyalty card accrues points or other rewards.

Buy now, pay later

Clearpay, Paypal and Klarna are some of the names you might see offering online ‘buy now, pay later’ options. It’s one of the options available for short-term borrowing for purchases. Like any credit agreement, if you miss a payment, it could cost you more.

Unsecured borrowing

Things like PayPal Credit, credit cards or some types of loans are an example of unsecured borrowing. Money is borrowed now, and an agreement is made to pay regular amounts until the balance is paid off. This can help spread the cost of a purchase over a few months, for example. If you miss a payment, you may be charged.

Student loan

Student loans often work in a slightly different way to traditional borrowing, the interest rates are usually lower and repayment terms may be different from traditional borrowing. If you are regularly paying a student loan, it may be taken into account as another outgoing on an affordability check. 

Where can you get credit?

Credit may be offered by lenders and service providers, such as:

Banks and building societies

Lots of people have a current account with a bank or building society. Banks and building societies usually have a wide choice of products, including types of credit – like mortgages, personal loans, car finance, credit cards and overdrafts.

Retailers

Some retailers offer credit that is specific to purchases made with them. You’ll also see branded credit cards (often in partnership with a bank), that you can use elsewhere or for different types transactions.

Credit unions

Credit unions are non-profit cooperatives. Alongside current accounts and savings accounts, they may also offer loans to their members.

Short-term borrowing

Sometimes called ‘payday loans’. The cost of a short-term loan is likely to be higher than other, longer-term credit options. There is now a cap on the amount of interest these ‘payday’ loans companies can charge.

Is it secured or unsecured borrowing?

What’s the difference between secured and unsecured borrowing?
 

Secured borrowing is when the amount that you have borrowed is secured against a belonging, like your home or car like a mortgage or car finance. If you don’t make payments on time and uphold your agreement, you could lose your car or house. 

The interest rates are usually lower than unsecured borrowing.

Unsecured borrowing isn’t secured against a belonging. Instead, an agreement is made with the lender for how you will repay the loan. Unsecured borrowing includes things like credit cards, loans and arranged overdrafts. 

The interest rates for unsecured borrowing tend to be higher than for secured. 

5 ways to manage credit

  1. Understand all the costs. When borrowing make sure you know all the costs involved, including interest, any fees or charges for late payments or additional costs. 
  2. Check your statements. Stay up to date with your accounts, including checking balances, payments and recent transactions. 
  3. Pay on time. Avoid additional fees or late payments charges by making your payments on time. Remember, some introductory offers or promotional interest rates are subject to payment terms.  
  4. Reduce what you owe. If there are no early repayment fees or conditions, reducing what you owe could reduce the amount of interest you pay. 
  5. Only borrow what you need. Only borrow what you can afford to repay.  

 

Knowing what you can afford

What is a credit score?

Lenders will often check your borrowing history. They want to see that you’re responsible with your finances and likely to repay credit.

They may contact a credit reference agency to view your credit report. And, they may also consider factors like your affordability and any past account history with them.

It can help to view your credit score. This will give you an idea of how you will be viewed by lenders and service providers.

Your Credit Score is a free service provided by MBNA. We’ve partnered with TransUnion, a credit reference agency, to provide you with access to your TransUnion credit score.

More on credit scores

How using credit affects your credit score

There are lots of things that affect your credit score, and how you manage credit is just one of them. The amount you borrow, your credit utilisation ratio and missed payments could all be reported in your borrowing history.  

Other things that could affect your credit score include, being on the electoral register and how you manage household bills. Financial links with other people could impact your ability to obtain credit if they have a poor account performance.

What affects your credit score

A quick recap

  • Credit gives you the option to pay for something now and to repay that money over a period of time, usually with interest. 
  • Interest fees, charges and other costs may apply. 
  • There are lots of types of credit available, from unsecured borrowing such as personal loans and credit cards to secured credit, like a mortgage or car finance. 
  • You can check your credit score to give you an idea of whether lenders will offer you credit. 

Keep reading

Applying for credit

How does a credit score work?
What is a bad credit score?
What is a good credit score?
Why has my credit score gone down?
What affects your credit score?

Using credit

What are interest rates?
How to consolidate debt
What is APR?
What is a balance transfer?
What is a money transfer?

Ways to borrow

Credit cards
Loans
Knowing what you can afford
How a credit card works

Know where you stand with MBNA

Sign up for ‘Your Credit Score’. We’ve partnered with TransUnion to provide you with access to your credit score. It’s free to use and won’t impact your credit file.

  • View your updated credit score every 7 days.
  • See what you’re doing well. 
  • Understand what you can do that might help to improve your score. 
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More on Your Credit Score