MONEY AND FINANCE

How Does Credit Really Work?

How Does Credit Really Work?

Credit is a stand alone word. Everybody not only knows what it is but how to use it. The how to use it part is the part that gets some people in trouble.

Maybe if they understood that there are only four types of credit they would be better able to use it and stay out of trouble. Understanding something is the first line of using it correctly.

As we all know credit is nothing more than having the use of something before you pay for it. Regardless of the benefits associated with such a transaction, understanding how each works lets you determine the right type and the right time to fit your particular situation.

The four types of credit are:

1. (1) closed-end redit
2. (2) open-end secured credit
3. (3)closed-end credit
4. (4)open-end unsecured credit

Each has its place on your credit landscape.

Secured credit is commonly used to purchase large items such as a home, car, or appliance. It is called secured credit because an asset, called collateral, secures the loan. Hence, secured.

With secured credit you are obligated to a series of payments. The payment frequency is usually monthly. If you fail pay per the contract terms, the creditor has the right to reclaim the collateral.

With closed-end secured credit, you will put down an initial deposit. The purchased item becomes the collateral. Most of us buy cars using this type of credit.

With open-end secured credit, you are usually in a revolving credit type of situation. The payment schedule may be single payment, equal payments or unequal payments. An example is a home equity line of credit.

Unsecured credit, as one might imagine, is credit extended without collateral. By the way, collateral is also known as security. Again, as one might imagine, there is a higher risk to the lender so the lender charge a higher interest rate for unsecured credit.

Closed-end unsecured credit is also known as signature loans or personal loans. These are usually repaid in equal monthly amounts.

Open-end unsecured credit operates under a credit limit. The borrower may use up to that amount but isn’t obligated to use it all. With this type of credit, the terms of repayment are in the agreement as is the credit limit. Credit cards are open-end unsecured credit.

Money and Finance