The concept of taking out credit has gotten a bad rap in recent years, following the subprime mortgage crisis in the US and rising levels of indebtedness in South Africa.
However if credit is used in a constructive way, it can prove to be a vital tool in building wealth creation for the future.
Here we discuss the various ways in which consumers can use credit to their financial advantage.
Property is a prime example of using good credit for wealth creation, as property owners use the bank’s money to finance their purchase, paying off a small portion each month while the property appreciates in capital value.
The obvious type of good credit is purchasing a property either as a main residence or as an investment and financing the purchase through a home loan. With interest rates still relatively low, the current market presents an opportune time to invest in property which is still one of the best investments.
Anyone who is purchasing property for investment purposes should make sure that the property is in an area where there will be sustainable capital growth and where there is a demand for rental properties.
Potential homebuyers should also negotiate the best rate concession from their bank, and if necessary shop around with other lenders in order to secure the cheapest credit and maximize their investment.
However, you must understand that property is a long-term investment not a ‘get-rich-quick’ scheme. You must be willing to hold onto your property through the dips and troughs such as we have experienced in the last few years.
2. Credit cards
Most consumers are surprised to learn that credit cards can also be a source of good credit if they are used wisely. Your credit card allows you to earn interest in your current account whilst you use the bank’s money to finance your purchases during the month. However, this will only work if you are disciplined and repay the full outstanding balance at the end of the month to avoid paying interest on your credit card.
3. Capital acquisition
Another type of ‘good’ credit would be any other capital acquisition that requires finance from a bank and that you can derive an income from.
A capital acquisition could be an investment in machinery or equipment or, of course, investment in property that is income generating. Credit for these sorts of assets makes you wealthier, it is only credit borrowed from the bank for luxury purchases like a car or clothing that make you poorer.
4. Debt consolidation
Debt consolidation is another example of good credit. Consumers can use the access facility on a home loan to settle their various retail and installment sale accounts. Your home loan rate will be much cheaper than the finance rates of your retail or installment sale accounts.
However if consumers use their home loan to settle outstanding debts and store cards, they must be vigilant to not use these cards again, particularly if they are still paying off the previous debt.
Finally, another suggestion is paying a higher installment on your credit facility than the minimum required by the bank to ensure that you attain your wealth creation goal as quickly as possible.
For example; a R20,000 lump sum deposited into a million rand bond will save you R118,857 in interest over the loan period, assuming that your interest rate is 10%. This means you will save more than five times the original amount as well as cutting your repayments to 18.8 years on a 20 year bond.