By Dominique Bowen
In December last year, 23.1 million South African consumers had at least a credit card, personal loan, vehicle loan, home loan or retail loan account. This is according to the 4th quarter 2021 Consumer Default Index (CDI) report released by credit bureau Experian, which measures and reports the rolling default behaviour of South African consumers holding these products.
As a nation we’d amassed R1.94 trillion in outstanding debt, which comes as little surprise considering how much we rely on credit, and often mismanage it, to our immediate and long-term detriment. Preventing mismanagement starts with understanding it, and that not all credit is created or offered equal.
Unsecured credit
The Experian report also found that the CDI improved in 2021, which the bureau attributed, in part, to lenders’ stricter criteria for extending credit, owing to their increased risk aversion. The nature and reputation of unsecured credit products, in particular, can contribute a great deal to this aversion. “Unsecured credit has the highest default rates; this can impact a consumer’s credit report and score significantly,” says Annelene Dippenaar, chief legal and compliance officer at Experian Africa.
So what is unsecured credit, exactly? It’s the type of credit that does not have any asset attached to it to serve as ‘security’ if a borrower is unable to repay their debt. As a result, the interest on an unsecured credit agreement is much higher than that of a secured credit agreement, because the lender is taking more of a risk on the borrower by lending a cash amount that could ultimately be impossible to recover if the worst were to happen.
On its own, unsecured credit is not ‘bad’. As the overarching credit philosophy goes, as long as you are borrowing from a reputable lender, and you manage your credit responsibly, it can unlock doors and make your goals a reality. This principle applies to unsecured credit. “When you apply for unsecured credit, you can have direct access to funds that you can use to meet a variety of needs,” says Francois Viviers, group executive of marketing and communications at Capitec. “For example, when you want to extend or renovate your home, unsecured credit gives you the freedom to use the funds to buy supplies, and to make payments to a builder if needed. You could also buy a second hand car that may not qualify for secured finance.”
The reality, and the reason lenders are becoming more reticent with their credit offers, is that unsecured credit takes discipline because once it’s granted, the credit is more accessible for day-to-day use, and it’s easy to overspend, says Dippenaar.
Examples of unsecured credit products are bank overdrafts, retail store accounts and short-term personal loans.
Secured credit
If you’re smart with your unsecured credit agreements, you’ll likely have an easier time being approved for secured credit agreements; in a way, the responsible use of one opens doors more easily to the other. Secured credit generally has a physical asset attached as security – be it a house, vehicle or something similar. It’s not the nicest way to think of it, but secured credit suggests that the lender can seize a tangible asset if you, as the borrower, were to default on your payments.
With the tangible asset in the picture, lenders are likely to be more generous with their interest rates. “This is because you have guaranteed your lender an asset in case any losses need to be recovered,” says Viviers. What this means in the long term is that, if paid up on time and consistently, the overall cost of credit on a secured credit agreement would be more pocket-friendly compared with an unsecured credit agreement of similar value.
And is that temptation synonymous with store cards, loans and overdraft facilities? It’s unlikely to be a factor for you here, too. “The [secured credit] loan is usually transferred directly to the person or company that you are purchasing, say, the house or car from, and not to your personal account,” says Viviers.
How they influence your credit score
Your credit score is largely built on responsible credit behaviour. “At its most basic, having a credit history that reflects good payment behaviour (no missed payments, late payments, or underpaid months) is the best way to build a good credit history,” says Dippenaar. However, this considered, a mix of both secured and unsecured credit is key to building this history. Too much unsecured credit can raise red flags for future lenders. So what does a good mix look like? An example, concludes Dippenaar, would be having a retail card (unsecured credit), cell phone contract and home loan (both secured credit).
PERSONAL FINANCE