SMARTER BANKING:
MAKE CREDIT WORK FOR YOU

Published by the Australian Bankers’ Association Inc

Edition 2, September 2010

Copyright, Australian Bankers’ Association

All rights reserved.

Important Note

This booklet gives information of a general nature and is not intended to be relied on by readers as advice in any particular matter. Readers should consult their own advisers on how this information may apply to their own circumstances.

Note: The version of this document differs from the original version created and printed in hard copy and available as a .pdf document. Changes have been made to enhance accessibility. Changes have been made to appearance and no text changes have been made, with the exception of page numbers and references to page numbers throughout the document as relevant for this version.

Table of Contents

Credit basics

Costs of credit

Different types of credit and credit providers

Applying for credit

Reversing or cancelling credit

Keeping credit under control

Credit and the law

Where to go for more info

All that jargon… glossary of terms

Introduction

Credit is another term for borrowed money.

Used effectively, credit offers some real benefits. Credit can help you achieve your financial goals. You can borrow money to purchase your home or buy a car – items you mightn’t be able to pay the whole price for upfront. Instead, you repay the loan over time and you get to use the items straight away.

A credit card can be a convenient way to manage your day-to-day expenses, if you’re disciplined and pay off the balance on your card in full each month. For example, credit cards are used by millions of people every day to pay for goods and services. Credit cards also give you the ability to shop over the phone or via the Internet 24/7.

However, it’s important to use credit responsibly. If credit gets out of control, there can be serious consequences for your financial health – it can have adverse effects on your relationships and put your financial goals out of reach. Managing your credit carefully will ensure it’s something that works for you, rather than becomes a burden.

This booklet contains essential information for anyone who is thinking about borrowing money, or who already has some form of credit, such as a personal loan, an overdraft, a credit card, or a home loan.

It provides the basic facts about credit – including the potential benefits and pitfalls of different types of credit, information on the cost of credit, and how to apply for credit. It also includes tips on keeping credit under control and explains what to do if credit becomes a problem for you.

When you’re reading this booklet, if you’re unsure of about the terminology used, you should check out the glossary at the back of this booklet.

Credit basics

What is credit?

Credit is borrowed money that allows you – the borrower – to buy goods or services now, but pay for them later.

The business that provides you with the credit is called a ‘credit provider’ (sometimes referred to as a creditor or a lender). In Australia, businesses that typically provide credit include banks, building societies, credit unions, finance companies, friendly societies, payday lenders, and retail stores or government bodies that offer credit.

When you borrow money you enter into a credit contract. Credit cards, store cards, an overdraft on your bank account, personal loans and even mortgages, all involve some type of credit contract.

A credit contract is legally binding and sets out the terms and conditions of the credit provided, including the cost of the credit – the price you pay for being able to make use of the borrowed money. Costs may include interest and fees.

Under the terms of a credit contract, you and your credit provider have certain responsibilities. For example, you must pay back the borrowed money within a certain period of timeand according to the terms and conditions of the contract. Your credit provider must give you important information about the credit facility, such as a full explanation of the terms and conditions, and any fees that may apply.

Did you know?

The new National Credit Code was introduced on 1 July 2010. For more information about the National Credit Code, see page 48 of this booklet.

Why use credit?

Credit can be a convenient way to buy goods and services without having to pay the whole price upfront. Buying on credit means you pay over an extended period of time – making it possible to buy larger items that you generally can’t afford to pay for immediately.

For example, a personal loan can make it possible to purchase a car, and then pay it off in instalments over a few years. A home loan makes home ownership possible for many Australians, as most people would simply never have the money to pay the full amount for their home upfront.

As well as making it possible to defer payment, some forms of credit offer a convenient way to manage day-to-day expenses. For example, credit cards give you the ability to shop over the phone or via the Internet 24/7. Paying by credit card also means you don’t have to carry around large amounts of cash for your day-to-day purchases.

Did you know?

As an alternative to a credit card, you could use a scheme debit card (e.g. Visa, Mastercard). Scheme debit is not a credit product. You can use a scheme debit card to access your own money to shop online, over the phone or give you 24/7 access to your money overseas using the scheme network. Many banks offer a scheme debit card along with their everyday bank account.

What is a credit contract?

A contract is a legally binding agreement between two or more parties. In the case of a credit contract, the contract is between you and your credit provider. The credit contract will stipulate the terms and conditions of the credit provided, including how much you’re borrowing, and the cost of the credit, including the interest rate and fees. It will also set out the way the credit is to be repaid, including details of frequency and amount of repayments. If it is a fixed term loan, the contract will also set out the term of the loan.

Before you sign a credit contract, make sure you read the contract and check:

  • The name of the business or person lending you the money
  • Details of the loan, including the term, any security or guarantee
  • How interest is calculated and charged
  • What fees and charges are applicable
  • If and how often you’ll receive the account statement and any changes to the terms and conditions of the credit contract.

Did you know?

A credit contract sets out the obligations the two parties have to each other. Both parties are legally obliged to comply with the contract. If one party does not meet its obligations, they’re in breach of the contract, and the other party can take them to court. The court can order the party in breach to fulfil the contract or to pay damages. If a customer suffered a loss as a result of a breach of the contract by their bank, then the banks’ external dispute resolution scheme may be able to deal with the matter instead of the court. For more information about external dispute resolution and the Financial Ombudsman Service (FOS), see page 52 of this booklet.

Tip: Managing credit responsibly

When you don’t have to pay for your purchases upfront, it can be tempting to buy expensive items you don’t really need. This can lead to trouble later on if you’re unable to make the necessary repayments. Be sure to keep your purchases on credit within sensible limits, and always consider whether you really need or want to buy the item and whether you can afford the repayments that will be required to pay off the debt.

What is a comparison rate?

Banks and other credit providers are required to disclose a ‘comparison rate’ alongside interest rates included in advertisements for their fixed term credit products, such as fixed term personal loans and home loans.

The comparison rate is a tool to help consumers identify the cost of credit. It takes into account the loan’s interest rate (sometimes also called the ‘annual percentage rate’), as well as certain fees that relate to the loan. For example, a personal loan may be advertised with an interest rate of 5.75% per annum, but once fees are taken into account, its comparison rate may in fact be 6.25% per annum.

Be aware: Looking at the comparison rate can be useful as it helps you compare loans. However, it’s important to understand its limitations. The comparison rate disclosed must be made on the basis of an assumed amount and term of loan that most closely represents the typical amount and term of the loan being advertised. Therefore, the comparison rate can only ever be an approximation and will vary depending on the actual loan amount and the actual term you want. The comparison rate disclosed also doesn’t include all fees (e.g. one-off charges that might only apply in certain circumstances, such as redraw fees, early repayment fees or overdue payment fees).

Did you know?

The cost of the loan is not the only thing that matters. The comparison rate doesn’t take into account other factors which may make one loan more attractive than another, such as discounts on other products offered by the same lender or flexible repayment arrangements.

What is consumer credit insurance?

Consumer credit insurance (CCI) is insurance that covers you if you’re unable to make repayments on your loan as a result of certain events. Three types of risk are usually covered by CCI:

  • death
  • sickness or accident, and
  • unemployment.

If you become unemployed or disabled, CCI policies pay part, or all, of your repayments on your loan for a set period. If you die, CCI may also repay the loan up to a set limit.

Some credit providers may offer CCI when you apply for credit. The premium is usually included in the amount you borrow, meaning you pay the premium off over time as part of your regular loan repayments. The cost of your cover often depends on your outstanding monthly balance.

Did you know?

Lenders Mortgage Insurance (LMI) is not insurance protection for the borrower. LMI protects lenders against a loss should a borrower default on their home loan. Many banks and other lenders require borrowers to contribute a 20% deposit before they’ll agree to provide a home loan. LMI can mean that you can purchase a home with a smaller deposit. The premium varies depending on the size of the loan, the loan type, and the level of deposit, and can be paid upfront or in some cases can be capitalised into the amount you borrow.

Tip: Considering consumer credit insurance

You should:

  • Understand what insurance is being offered – what it covers (e.g. what kind of circumstances the insurance covers and how long payments would last) and how much the insurance costs
  • Read the CCI policy wording carefully – does the insurance meet your needs
  • Consider whether you need this insurance – decide whether the risks you’re taking are worth the cost of the insurance.

You need to consider whether CCI is the best insurance option for you.

Tip: Understanding the “Ts and Cs”

Make sure you understand the “terms and conditions” of the credit contract before you sign it (or sign the offer). Once the contract has been formed, you’re legally bound by it – even if you’ve not read the terms of the contract. If you don’t meet your part of the agreement, the credit provider can take legal action against you.

What is my credit history?

A credit provider will consider various factors when deciding whether to approve your application for credit. One of the things a credit provider will look at is your credit history.

If you’ve used credit in the past, and there is no record of a default in your repayments and there is nothing to suggest that you’ve got multiple credit facilities that could mean you’re overcommitted, this will increase your chances of being approved for credit. A demonstrated ability to repay shows that you’re more likely to be ‘creditworthy’.

It’s important to understand that any time you use credit, in the process, you establish your credit history. If you don’t meet your obligations under the credit contract, not only may there be problems with your existing credit provider, but you also may damage your ability to get credit in the future.

Your credit report held by a credit reporting agency is the official record of your credit history. Credit providers can obtain a credit report from the credit reporting agency and use the report in deciding whether to approve you for credit. For more information about your credit report, see page 28 of this booklet.

Credit checklist: Ways to maintain a healthy credit history

  • Don’t borrow more money than you can afford to repay.
  • Make sure you pay your bills punctually.
  • Keep copies of all your financial records in a safe place.
  • If you think you may be unable to meet your repayments call your credit provider to discuss the problem with them so that you can work with them to put in place a repayment plan to assist you.
  • If you need help managing your finances, speak to a free and independent financial counsellor. A financial counsellor can help you put in place a budget and work with you and your creditors. For more information about financial counsellors, see
    page 51 of this booklet.

Costs of credit

Borrowed money comes at a price, in the form of interest, fees, or both.

The cost of a credit arrangement will depend on a number of factors, including:

  • the type of credit
  • the amount you borrow
  • the type of provider offering the credit
  • the time you’ll take to repay the debt, and
  • whether the credit is secured or unsecured.

Generally, the more you borrow and the longer you take to pay it off, the more interest you’ll pay.

What is interest?

Interest is the amount you pay to the credit provider for the use of their money. Interest is calculated as a percentage of the amount you still owe, and is usually payable at regular intervals over time.

The type of interest can vary depending on the credit product and the credit provider. For example, personal loans may be described as fixed rate or variable rate loans, while credit cards may offer interest-free days or ongoing interest.

Fixed rate loans

Fixed rate loans mean the interest rate is set for the life of the loan. Your repayment amount and frequency are usually set at the beginning of your term. With such loans, you may have to pay an early repayment fee if you make additional repayments along the way or if you pay out your loan earlier than the agreed term.

Repayments for fixed rate loans are easy to include in your budget because you’ll always know what your repayments will be. As the interest rate is fixed, you’re protected from increases in interest rates, but you won’t get any benefit if interest rates fall.

You may be able to get a fixed rate loan which is ‘interest only’, meaning that the principal is repayable at the end of the loan and you make only interest payments during the term of the loan.

Variable rate loans

Variable rate loans have interest rates that are subject to change. Such changes may occur at the credit provider’s discretion, or in line with changes in market rates. Generally, if market rates go up, so too will the repayments on your loan, while if market rates come down, your repayments will fall.

With most variable rate loans you can choose the frequency of your repayments to be included in your credit contract. For example, you might choose to make a repayment weekly, fortnightly or monthly. You may also have the freedom to make additional payments at any time, or increase the amount of your regular repayment.

Variable interest rates typically apply to personal overdrafts and credit cards.

Tip: Paying off your loan

If you’ve got a variable rate loan, there are some strategies which can help you pay off your loan faster and save on your overall interest costs.

You may be able to choose the frequency of your repayments in your credit contract (e.g. weekly, fortnightly or monthly).

You may also be able to make additional payments at any time, or increase the amount of your regular repayment. Depending on the loan and how long you’ve had the loan, you may incur an early repayment fee if you pay out your loan early.