Types of Credit
Credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date. It allows you to buy now with the promise of paying later. By understanding how each type of credit works, you will learn to manage credit successfully.
Loans let you borrow money that must be repaid with interest. You can obtain a loan for a specific purpose, such as financing a new car, paying college tuition, or buying or renovating a home. Loans are generally divided into two types: secured and unsecured.
- Secured loans are guaranteed by collateral, which is an item of equal or greater value than the amount of the loan, such as a car, home or cash deposit.
- Unsecured loans do not require collateral and are made based on your credit score and ability to repay. Examples of unsecured loans include credit cards and student loans.
2. Installment Loans
Installment loans are made for a fixed amount at the time of your application and approval. This type of loan is repaid in fixed monthly payments over a specific period of time. The interest charges are included in the payments. Auto loans and mortgages are examples of installment loans.
3. Credit Cards
Credit cards are perhaps the most common type of personal credit. Unlike installment loans, credit cards allow repeated transactions up to a maximum credit limit, also known as your available credit limit. Each time you charge something, you are borrowing the money until you pay it back. If you decide to pay the money back over time, the credit card company adds interest charges to your account. Each month, you will pay a calculated amount until the borrowed amount is paid in full.
What is a credit card?
A credit card is a card issued by a bank or business to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services later. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance.
Credit cards bill monthly, with a grace period built in that lets the consumer borrow short-term credit between the time they make the purchase and when it is due. If balances are carried over from month to month the user will be charged interest.
Credit cards are a form of borrowed money. Each time you use a credit card, you are using money that you will have to pay back later with interest.
Credit cards are easy to use because they give you instant buying power for items you may not otherwise be able to obtain; and because of this people can find themselves in debt quickly if they don’t have a plan. Credit card interest rates are typically very high and may range from 12% to 23%. The longer you take to pay the money back, the more interest you pay on the money you borrowed. Credit cards should be used only for purchases that can be paid in full at the end of the month.
What should you know before you obtain a credit card
What is the interest rate?
Interest can be earned or paid out, and it is always a percentage of the original
amount of money involved in the transaction. Interest paid is the amount that a bank
charges you for borrowing their money.
Simple interest: Simple interest is when interest can only be earned on the amount borrowed or invested (this amount is called the principal).
Compound interest: Compound interest is calculated not only on the money originally invested, but also on the accumulated interest.
Variable interest: This is tied to another interest rate, usually one that moves up and down with the economy. It will go up or down as the underlying interest rate fluctuates.
Fixed interest: A fixed interest rate doesn’t necessarily remain fixed. In fact, credit card issuers are allowed to change a fixed interest rate, but only under certain circumstances. Right now, credit card issuers are required to give cardholders are 45-day advance notice before raising a fixed interest rate. Card issuers are also required to give cardholders the opportunity to opt-out of the interest rate increase and allow them to repay their balance at the old interest rate.
What is the annual fee, if there is one?
A credit card annual fee is a fee automatically charged once a year to your credit card account for the convenience of the credit card. There are cards with and without this fee, be a smart consumer and try to avoid the annual fee if you can.
What is the late fee?
The late fee is as the name implies: the fee you pay for being late on your monthly payment. Be aware that late fees are capped at $25, so make sure you are not being charged more than that!
What is the over-the-limit fee?
The over-the-limit fee is a fee charged when your balance goes over your credit limit.
Do they offer a grace period?
Remember, a grace period is the amount of time you have to pay your bill without paying interest on it.
What is the credit limit?
This is simply the amount of money that can be charged to the card. It is determined by the credit card based on their analysis of several factors, and can increase over time as you build good credit. Keep charges below your credit limit, as this will improve your credit score.