What is credit?

Although they all have a similar purpose, there are many types of credit to choose from.

A brief description of credit

Very simply, credit makes it possible to borrow money now and repay it over a period of time, which could be helpful if you’re planning a large purchase, want to consolidate existing debt balances, or need to manage unexpected costs.

For extending credit to you, lenders and other service providers may charge interest, fees and other costs. Your borrowing costs will depend on the terms of your credit agreement, how much you borrow, and how long it takes to repay.

How does credit work?

All credit products work slightly differently, depending on their purpose, but features may include:

A credit limit

Common on credit cards, overdrafts and store cards, the clue is in the name. This is a pre-agreed amount you can borrow up to, without being charged additional over limit fees. If you go over the maximum credit limit, in addition to fees, your credit score could be impacted.

Interest rates

Essentially a charge for using credit, the amount of interest you’ll pay is worked out as a percentage of the money you borrow. Generally speaking, the higher the percentage, the more it’ll cost to borrow, and vice versa.

Monthly payments

Most credit products require you to make regular payments, as detailed in the terms and conditions of your credit agreement. It’s important to make payments on time to avoid additional fees and charges, losing any introductory or promotional interest rates, and to prevent any negative impact to your credit score and record.

Fees and charges

In addition to interest, things like annual fees may apply to some accounts. Charges may apply for things like missed or late payments, going over your credit limit, cash withdrawals and using cards outside of the UK. Refer to the terms and conditions of your account to understand all costs.

Types of credit

There are many types of credit available. Below we’ve provided descriptions of the main ones:

Credit cards

A credit card offers you a flexible way to manage your credit needs over time, helpful for spreading the cost of purchases, consolidating existing debts or giving you access to cash when you need it.

You can use a credit card in many retail stores, online and at compatible cash machines around the world. Just be aware, different interest rates, fees and charges may apply to individual transaction types.

More about how credit cards work

Personal loans

A personal loan could offer you a fixed borrowing amount, over a term to suit your budget – typically 1-7 years. If approved, the money will be deposited into your selected UK current account, ready to use.

Interest can either be fixed or variable. At the end of your loan term, so long as you’ve made all of the necessary payments, your balance will be repaid in full, which could be helpful if you’re focussed on limiting new borrowing, and clearing old debts.

More about personal loans

Car finance

If you’re buying a car from a dealership, there are finance options you might like to explore:

With a Hire Purchase plan (HP), you’ll make fixed monthly payments over 1-5 years, and at the end of your agreement you’ll own the car outright, with no mileage limits to worry about.

Personal Contract Purchase (PCP) plans offer lower monthly payments over 1-4 years, with the option to return, exchange, or pay a lump-sum at the end of the agreement to own the car. Just be aware that mileage and return conditions may apply.

More about car finance

Overdrafts

An overdraft is a form of borrowing attached to your current account, which can act as a short-term safety net, whether you need a little extra to cover unplanned expenses, or just to tide you over when you’ve run out of money.

Using an arranged overdraft carefully, i.e. limiting how much you use it, paying it off regularly and staying within your overdraft limit, can boost your credit score. Managing it poorly can do the opposite.

Some banks and building societies will allow you to use an unarranged overdraft, however your credit score could be negatively impacted if you do.

More about overdrafts

Mortgages

A mortgage is a type of loan, enabling you to buy a property, against which the loan is secured. It’s important to know, if you don’t keep up with your repayments, you could lose your home.

A mortgage term could be as long as 40 years, depending on your age and borrowing needs, with both fixed and variable interest rate options available. It’s likely you’ll need to pay a deposit in addition to anything you borrow.

On repayment mortgages, you’ll pay more towards interest at the start, and less as you reduce the balance owed over the mortgage term.

On interest-only mortgages your monthly payments could be lower, but you’re not reducing your balance during the mortgage term, and you’ll need to repay the full amount at the end.

More about mortgages

Store cards and credit

Some retail brands offer credit, enabling you to make purchases now and spread the costs over a period of time. Essentially, this works in the same way as a credit card or loan, limited to purchases made with one individual brand or store. Some may also offer tailored benefits and loyalty rewards.

Much like other credit products, interest, fees and other charges may apply, and you’ll need to make regular repayments.

These shouldn’t be confused with cards used solely to collect loyalty points, or retailer branded credit cards, which can be used for other transaction types, and elsewhere on the high street.

‘Buy Now Pay Later’

Companies like Paypal, Klarna and Clearpay give you the option to make online purchases now, and pay in instalments over a few weeks or months.

This service could be offered with no interest, fees or impact to your credit score, as long as you keep up with your payments, making it a popular choice for short-term borrowing. If you miss a payment, fees and charges may apply.

Unsecured borrowing

As well as more traditional forms of borrowing, you might see options like PayPal Credit when you shop online, which could help you to spread the cost of larger purchases over a few months.

As with any types of credit, it’s important to keep up with repayments to avoid any negative impact to your credit score.

Student loans

Although often offered at low interest rates, a student loan is still a form of debt, which may affect your credit eligibility and score until it’s repaid in full.

As with any other type of credit, missing a student loan payment may impact your credit score.

Secured or unsecured – what’s the difference?

Examples of secured borrowing include mortgages and some forms of car finance, where the money you’ve borrowed is secured against one of your possessions, such as your home or car.

If you fail to meet the terms and conditions of your credit agreement, including making regular repayments on time, in addition to damaging your credit score, your property could be repossessed.

However, one benefit of secured borrowing is that your interest rates may be lower, even if you pay a variable rather than a fixed rate.

Examples of unsecured borrowing include credit cards, personal loans and overdrafts, where the money you borrow is not secured against one of your possessions. As a result, your borrowing costs could be higher.

It’s still important to manage these accounts carefully though, as failing to meet the terms and conditions of your credit agreement, including making regular repayments on time, could negatively impact your credit score, potentially making it more difficult to get further credit in future.

Who provides credit?

Lenders and service providers who offer credit services in the UK, regulated by the Financial Conduct Authority, may include:

Banks and building societies

Most people have a relationship with financial institutions, like Lloyds Bank, helping them to manage their savings, investments, borrowing needs and day-to-day finances.

Banks and building societies usually offer the widest range of credit products, including mortgages, credit cards, personal loans, overdrafts and car finance.

Retailers

Supermarkets, department stores and some other retailers or service providers may offer credit solutions to customers, enabling them to buy now and pay later. This usually takes the form of:

  • A store card or account, enabling you to make purchases with a single brand or store.
  • A retailer branded credit card, which can be used elsewhere on the high street, and for other types of transaction. These credit cards may, in fact, be provided in partnership with a bank.
  • Finance agreements on larger purchases, such as a car, furniture or expensive electrical goods.

Credit unions

These are non-profit co-operatives run by members, for members, often formed by groups with close associations, such as trade unions, clubs or religious organisations.

In addition to current and savings accounts, credit unions may offer loans to their members.

Short-term lending

Some companies offer flexible borrowing options, often referred to as ‘pay day loans’, which could tide you over for a short period of time.

There is now a cap on the amount of interest which can be charged for these services. However, the costs are still likely to be significantly higher than many other borrowing options.

5 tips for managing credit

  1. Only borrow what you need and can reasonably afford to repay. Try to find introductory or promotional interest rates if they’re available to you.
  2. Make sure you understand the cost of borrowing, including interest, fees and other charges.
  3. Regularly check your statements and online accounts, helping you to keep track of your balances, payments due and recent transactions.
  4. Make payments on time to avoid extra fees and charges, losing any introductory or promotional interest rates, and to prevent any negative impact to your credit score and record. Setting up a Direct Debit could be one way to ensure you pay on time, so long as there are funds available in your nominated bank account when your payment is claimed.
  5. Repay as much as you can, wherever possible, to reduce your balance and the amount of any interest you pay overall. Just be aware that early repayment charges may apply. This could also help you avoid falling into persistent debt.

Knowing what you can afford

What is a credit score?

When you apply for credit, lenders and service providers contact their preferred credit reference agencies to check your credit record. This may highlight any potential risks associated with offering you credit, and can influence the interest rates and any amount of credit you’re offered.

Not only that, but lenders and other service providers complete their own credit scoring (PDF 915kb) when you apply for credit, including information from your credit record. They also consider factors like affordability and any past account history.

More about credit scores

How using credit affects your credit score

The way you use and manage credit is just one factor which could impact your credit score, although the amount you borrow, the age of your accounts and how well you manage payments and credit limits can all have a bearing on your rating.

Other factors include being on the electoral register, how often you move home and change your address, how well you manage household bills, and even who you have financial links with.

What affects your credit score?

Key points about credit

Credit makes it possible to borrow money now, and repay it over a period of time.

  • Interest, fees and charges may apply to anything you borrow.
  • There are many types of credit available, including personal loans, credit cards, mortgages, car finance and overdrafts.
  • Borrowing can be either secured, which is the case for mortgages, or unsecured, like credit cards.
  • To avoid additional fees, charges and any negative impact to your credit score, it’s important to make repayments on time and stay within any agreed credit limits.

Where next?

Know where you stand with Lloyds Bank

Sign up for ‘Your Credit Score’ to see your rating with TransUnion. It’s free to check and won’t hurt your credit score.

More about Your Credit Score