Consumer Finance/Credit: Disadvantages & Advantages
Consumer credit refers to various types of personal credit that individuals are already aware of. This includes credit cards, mortgages, car loans, and personal loans. It encompasses both unsecured loans and programs that enable individuals to buy goods and services while dividing the cost over a period of time.
Consumer credit is provided to individuals either by retailers or by larger institutions such as credit card companies and banks. It encompasses all forms of personal debt, enabling shoppers to make immediate purchases and gradually repay the cost, typically with added interest.
Demand for consumer credit
In every country, this form of access to consumption is highly in demand, since the economy is consumption based. The function of consumer financing is to allow consumers to defer payment of purchases and pay with interest at a predetermined and sometimes variable interest rate. Many consumers use it to purchase durable consumer goods and services at higher prices, such as televisions, stoves, computers, refrigerators, clothing, footwear, cars, home or car repairs, travel, among others; it is also common for many retailers and for impulse purchases. The debtor receives a sum of money that he promises to repay to the institution or financial company that granted it, in an agreed term and with certain interest (which depend on the interest rate of the financing).
Read more: FAQ on consumer loan
Advantages of Consumer Credit:
(1) Convenience and immediate access: Individuals can make purchases without paying the full amount upfront through consumer financing. This is particularly useful when purchasing costly items, such as electronics, furniture, or appliances. It offers the convenience of obtaining the product right away, even if the complete cash amount is not available and without having to present documents as collateral. It can be obtained by individuals without having a credit history. This is why some people refer to it as “small payments”.
(2) Budgeting and managing expenses: Generally, the payments are monthly and are paid in 24, 36, 48, 60, 72 or more months; according to the plan, the payment capacity, the amount and the institution. By distributing the cost of a purchase over time, consumer financing can assist individuals in managing their cash flow. This approach enables better budgeting by allowing fixed monthly payments instead of draining savings all at once.
(3) Building credit history: Making timely payments while using consumer financing is a responsible approach that can aid in developing a favorable credit history. This can prove to be beneficial while applying for upcoming loans or credit cards, as lenders frequently take credit history into account when evaluating applications.
Check out: Consumer loan for low income earners
(1) High interest rate and fees: One of the biggest disadvantage of consumer finance is the high interest rate. When opting for consumer financing, it is common to encounter interest charges and fees that can substantially inflate the overall expense of the acquisition. Therefore, it is crucial to meticulously scrutinize the terms and conditions, comprising the interest rate, repayment duration, and any supplementary fees implicated. If the consumer is unaware of these charges and fees then it is detrimental to his/her financial health.
(2) Impulsive buying and overspending: Another disadvantage of consumer credit is the attraction of deferred payment that entices people to buy items they wouldn’t normally be able to purchase. This behavior can result in overspending and potential financial instability, if the repayment terms become too difficult to manage.
(3) Accumulating debt is another disadvantage of consumer loan especially when it is taken without a repayment plan. It is essential to evaluate your financial status and verify that you can manage the necessary payments with ease. Neglecting this step can cause financial stress and have an adverse effect on your credit rating. A damaged credit rating on our credit bureau due to unpaid financing can negatively affect a consumer’s ability to obtain new personal or business financing.
(4) Impact on credit utilization: Your credit utilization ratio can be impacted by consumer financing, especially with credit cards or lines of credit. This ratio is the proportion of credit you’re currently using in relation to your overall available credit. If you use a substantial amount of your available credit, it can lead to a reduction in your credit score and may make it challenging to secure future loans or credit.
(5) Hidden costs and penalties: It is important to note that certain consumer financing contracts may contain undisclosed expenses or fines that are not readily visible. These may include charges for late payments, penalties for early repayment, or fees for surpassing credit limits. It is essential to meticulously review the terms and conditions in order to grasp the possible expenses associated with the agreement.
(6) Limited flexibility and commitment: By entering a consumer financing agreement, you obligate yourself to make consistent payments for a set duration. This may constrain your financial adaptability and could hinder your capability to save or invest in other domains. It is crucial to contemplate the enduring obligation and guarantee that it corresponds with your comprehensive financial objectives.
(7) Potential impact on future borrowing capacity: Your capacity to borrow for future purposes may be affected if you have substantial consumer financing obligations. Lenders take into account your current debts and financial responsibilities when assessing your creditworthiness. A high debt-to-income ratio can pose a challenge in securing favorable loan or credit terms in the future.
(8) Risk of default and collection actions: Failing to meet your consumer financing obligations may result in default. Defaulting on a loan or skipping payments can bring about severe outcomes, including harm to your credit score, being subjected to collection efforts, or even facing legal repercussions.
6 Tips before Applying for Consumer Loan
Keep in mind the following recommendations to make good use of your financing:
(1) Save: If we promote it in the family and carry out this activity, surely we will always have the necessary money to buy what we need or want, without having to get into debt.
(2) If you are determined to buy by this route, then analyze several options and your personal situation in order to decide the one that best suits you.
(3) Don’t resort frequently to this type of purchases that offer you the possibility of weekly or monthly payments.
(4) Don’t get ahead of yourself, check before you buy the product if you can buy it without the need for financing.
(5) Remember not to confuse the overpricing of a product with the interest rate, this is separate.
(6) Don’t forget to analyze your ability to repay, on that basis you will determine the amount of financing that suits you.
Consumer financing can be beneficial if used responsibly and within your means. Before opting for consumer financing, carefully consider the terms, interest rates, and your ability to make timely payments. It’s important to maintain a balanced approach to ensure that your overall financial well-being is not compromised.
Hi, I am Nikesh Mehta, owner and writer of this site. I’m an analytics professional and also love writing on finance and related industry. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business. I can be reached at [email protected].