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4 types of credit and deep dive into credit types

Four Common Forms of Credit.

What is credit?

Credit is defined in several ways. One is the amount of money you are approved to borrow from a lending institution. With this approval comes an agreement to repay it with interest, additional fees that can be applied, and a certain time to pay back the complete amount with interest. Credit is classified as your borrowing reputation. It paints a picture to the lenders of your payment history and provides the lender with information regarding the likelihood of you repaying the borrowed amount with interest. They put on a risk ladder, the lower you are on it the more money they are likely to lend to you as you are considered a good borrower in their eyes, the higher you are on the ladder the harder it will be for you to get a loan and even if you do, the interest rate will be high because of the extra risk they are taking by lending you money.


Using Credit To Your Advantage


Credit is essentially a financial tool, if you learn about credit and how to increase your score you will be ahead of the curve. Credit is woven into the fabric of the American way of life from a simple credit card to an auto loan to a home mortgage loan. Cashless transactions are soon becoming the way of the future, and credit cards are among the most prevalent. Understanding credit is important to use credit to your advantage and prevent the common financial pitfall known as debt.


Four Major Forms of Credit

  Revolving Credit


You can borrow money up to a particular amount with this type of credit. A credit limit, or the maximum amount you can borrow, is set by the lending organization. The borrower in a revolving credit account rotates the balance from month to month until it is paid in full. Any revolving balance is subject to interest charges. As the money is repaid, the difference between the maximum credit limit and the current credit limit shrinks as you make payments. Revolving credit is most commonly seen in credit cards.


Charge Cards


This type of credit is frequently confused with a revolving credit card but charge cards are known to be more advantageous in not building credit card debt, unlike credit cards that allow for revolving credit. Charge cards don’t typically operate as regular credit cards as they require you to pay the complete balance every month. Charge cards usually don’t have a spending limit as well as no interest rate. Failure to pay the full amount by the end of the month may result in penalty fees. An example of a well-known charge card is American Express. Charge cards are known to be more advantageous in not building credit card debt. Charge cards are known to charge high annual fees while you can find credit cards with no annual fees and decent interest rates.


Installment Credit


Installment credit entails a fixed loan amount, a fixed monthly payment, and a fixed payback period. Interest rates are set in advance and factored into the monthly payments. Home mortgages and auto loans are two common types of installment credit arrangements.

Installment credit is also typically secure. Secure credit requires security for the lender. The borrower must provide collateral to guarantee loan repayment. If the borrower fails to repay or defaults on the loan, the lender may confiscate the collateral. A home is an example of collateral on a mortgage, and a vehicle on an auto loan. If the borrower were to default, the home or vehicle would be repossessed.


Non-Installment or Service Credit


This form of credit allows the borrower to pay for a service, membership, etc. at a later date. Generally, payment is due the month following the service, and unpaid balances will incur a fee, interest, and/or penalty charges. Continued non-payment will result in service cancellation and can be reported to the credit bureau, affecting your credit score. Service or non-installment agreements are very common in our everyday life. phone, gas and electricity, water, and garbage are all examples of service credit.

Credit Over The Years.

Very many years ago, more like eons ago. Credit was something that was rendered to the privileged few. It was as simple as a merchant giving credit to a person he/she could trust to pay him/her back. Anyone without the means, repute or modest could not get the much sought-after “credit”.

This simple concept of rendering credit progressed into making it available to each and everyone in a myriad of ways. Via multiple and diversified products such as credit cards, mortgages, automobile loans, student loans, etc. Soon, credit was not limited to just merchants. It spread to financial and non-financial institutions whose business was to lend money. And to be a person of repute or privilege was to be able to prove his/her ability and standing to get a loan and pay it back too.

This opened avenues of risk and control and lending became the need of the hour; from cradle to grave, because credit lives on in the family name well after. Not to mention the corporate commercial loan which also uses the basic concept of credit but with the method of amortization.

 Coming back to consumable retail/personal credit, it’s always important to understand that the eons old theory still remains at its core. That is, finance is extended to the person/end user who is known for his/her capability and ability to pay it back.

Then follows the concept of institutions making a profit during the repayment period, because the pursuit of profit is inherently what finance lending is all about. In today’s world improving your credit worthiness is as crucial as the healing of the ozone layer of the earth. So get those oxygen levels hiked up and start working on your credit worth as soon as you evaluate how your credit score infers. Since credit lines are worked and reworked on the income/spending and delinquency behavioral pattern of an individual. The more one spends carefully, the sooner one reaches the outstanding, well-revered credit score.

Contributor : Beena Karkhanis