The difference between credit cards and finance

Credit card

When it comes to making big purchases, consumers are generally faced with three options. You can either save up and pay for it outright, buy on finance, or pay with credit.

Depending on how expensive the item in question is, saving up could take months, or even years, which is far from ideal. This is even less helpful if you need to make the purchase in an emergency like, for example, buying a new car, fridge, or boiler. In these instances, you’re left with a choice between credit or finance. While these might seem similar in principle — both require paying off a loan for a specific purchase — there are some key differences between them.

Consumer finance companies offer set loans

These companies give consumers the opportunity to take out a loan against their personal assets, giving them the option to make a purchase they otherwise wouldn’t be able to afford. However, it’s important to note that this loan never actually enters an applicant’s account, and instead goes straight to the retailer selling the goods. As such, financing a purchase is made against specific items. You can’t make general everyday transactions on finance, like your shopping or getting fuel for your car, but you can use it to pay for a new kitchen, or the car itself.

Repayment plans are worked out on a fixed-term basis, with regular instalments being made over a period of time, such as a mortgage. The lending company will typically work with you to agree on a repayment plan, which may span anywhere from a few months to a few years, depending on the size of the loan and how much you’ll repay every month.

Credit cards allow cardholders to borrow funds

If you have a credit card, you’ll be issued credit via a bank, credit union, or any other financial institution, depending on the card you choose. There is usually a limit on the funds you can borrow depending on your credit history, but you’re under no obligation to reach this limit each month. There also isn’t a limit on what the credit can be spent on, which means that most people with credit cards will use them for a variety of different services and purchases. However, you always have to pay back the borrowed money, plus interest, as well as any other additional charges. The minimum monthly payment is dependent on how much you spent during the billing period, and interest will be added onto any unpaid balances. Once you’ve paid off your credit card, you can go back and reuse the credit, provided you continue to pay it off.

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You need a good credit score for finance and credit

One of the biggest similarities between finance and credit is the fact that you need a good credit score. Also known as a credit rating, this grade is given to you based on how likely you are to repay the money, which is crucial to being accepted for both credit and finance. As noted in CarFinance+’s guide to credit scores for car loans, there isn’t an “ideal credit score”, but it is more difficult to be approved for finance the lower your credit score is. Lenders are actually more interested in the contents of your credit report, as well as personal details such as income, whether you’re on the electoral roll, and any previous loans.

If you have a bad credit rating, or you’re worried about being refused credit or finance, there are things you can do to improve it. Some of these can make an immediate impact on your score, while others will take time to have an effect.

Register on the electoral roll

By proving where you live, and registering on the electoral roll, you can immediately boost your credit score, as lenders can easily confirm your name and address.

Build a credit history

Having no credit history can actually work against you when it comes to being approved for a loan or credit card. as lenders won’t be able to assess whether you can make the repayments. This can deter banks from offering you a credit card, and keep finance companies from providing a finance scheme.

Make payments reliably

By paying your accounts in full and on time every month, lenders can see that you’re able to manage your finances properly. Holding an account for an extended period of time, and managing it well, can hugely improve your score.

Keep credit utilisation low

This is the percentage of your credit you actually use. So, if you have a credit limit of £3,000 and you use £1,500, you have a credit utilisation of 50%. Keeping this low (ie. not maxing out your credit cards) proves to lenders that you don’t borrow more money than you can realistically repay.