What Is Credit and How Does It Work

Let’s explore what types of credit exist, how banks assess a customer’s ability to repay, how to choose the most favourable terms, and what to pay attention to before taking out a loan.

What Credit Really Is

Credit is a financial service that benefits both parties — the borrower and the lender. The borrower gains quick access to needed funds, while the lender earns income in the form of interest on the money lent.

Main Types of Credit

Credits differ by purpose, repayment period, security, and other criteria. Below are the most common types found in South Africa.

Personal (Consumer) Loan

This is money that a bank lends to a customer after approving their application. It can be spent on anything — education, travel, appliances, renovations, etc. There’s no need to report to the bank on how the funds were used. These loans are usually small, require minimal documentation, and often don’t need collateral or guarantors.

Purpose-Specific Loan

In this case, the funds are transferred directly to the seller of a product or service — for example, a car dealership or a property developer. Common examples include mortgages and vehicle loans. The loan’s purpose is fixed in the contract, and the funds can’t be used otherwise. The purchased asset remains pledged to the bank until full repayment. If the borrower stops paying, the lender has the right to repossess the asset.

Short-Term and Long-Term Loans

By repayment period, loans are divided into short-term (up to 12 months) and long-term (from one year and more). Short-term loans involve smaller sums and require fewer documents, but the interest rate is usually higher. Long-term loans involve larger amounts and a more thorough background check — but are generally cheaper due to lower interest rates.

Secured and Unsecured Loans

Collateral can be in the form of property or a third-party guarantee. If the loan is unsecured, the bank’s risk is higher — which is why such loans come with higher interest rates.

Annuity vs Differentiated Payments

Loans can be repaid through annuity or differentiated payments.

With annuity payments, the monthly instalment remains fixed — it already includes both the principal and interest.

With differentiated loans, the principal is divided into equal parts, and interest is charged on the remaining balance. This means payments gradually decrease each month.

Revolving Credit

This category includes credit cards. The client can make purchases within a set limit and repay the borrowed amount in parts. Funds can also be withdrawn from ATMs — although often with an additional fee. Such cards usually have an interest-free grace period and an annual service fee.

Forms of Credit by Source of Financing

Loans differ by where the money comes from:

Bank Credit

Issued by a bank, which sets its own terms and interest rate (within the limits allowed by South African financial regulations). All conditions are fixed in the agreement and can only be changed by mutual consent.

Government Credit

Here, one party is the government, while the other may be another state, an organisation, or an individual. Examples include student financial aid programmes or government-backed housing loans.

Commercial Credit

Businesses often provide each other with deferred payment for supplied goods or services. This form of loan is known as commercial credit, and the parties decide its conditions independently.

Documents Required to Apply for a Loan

A bank requests documents not only to verify your identity but also to assess your financial position — in order to determine the potential loan amount and interest rate. If your documents show that repayment could be difficult, the bank may lower the loan amount or increase the rate to reduce its risk.

Proof of Identity

The main document is your South African ID (or passport for foreign nationals). In some cases, an additional document may be required — for example, a driver’s licence.

Proof of Employment or Income

Formally employed applicants usually provide a recent payslip or a letter from their employer. Self-employed individuals can confirm income with bank statements or tax returns.

The Role of Credit History

One of the key factors in loan approval is your credit history. If it contains overdue payments, they should be settled first. A clean, positive history significantly increases your chances of approval.

Responsible Borrowing: Key Tips

Before applying for a loan, carefully evaluate whether it’s truly necessary. It may be better to reduce expenses or find an additional income source. Borrow only when absolutely necessary.

If you do decide to borrow, carefully calculate your monthly instalments and make sure that after repayment you still have enough funds for daily living and unexpected expenses.

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