Credit (finance)

Credit is money that people borrow and pay back, usually with interest. Interest is a charge for borrowed money. Credit is essentially a debt, an amount of money that is owed. Several types of credit exist, including credit cards and loans. Credit also can refer to a person's financial record that is known as a credit report. The credit report shows how likely a person is to pay off debt.

Loans

Financial institutions such as banks offer loans to individuals and companies looking to obtain cash. Loans are debts that must be repaid according to the repayment conditions and terms set forth by the financial institution lending the money. Most loans charge interest that must be repaid with the loan.

Loans are a type of installment credit. Installment credit is a type of payment plan. It usually requires a down payment and the rest is paid in a set number of equal installments. Loans also can be paid off in full at any time. Homes, cars, furniture, and other goods are typically bought with installment loans.

Generally, there are two types of loans: secured and unsecured loans. Secured loans are loans that are connected to collateral to protect the lender if the borrower defaults (does not pay) on the loan. Collateral is an item of value such as a car or home. If a borrower does not pay back the loan, the lender becomes the owner of the collateral. For example, if a person does not pay his or her mortgage (home loan), the bank becomes the owner of the home. Mortgages and car loans are types of secured loans. Secured loans typically are easier to get because less risk exists for the lender. They also have lower interest rates and typically are for higher amounts.

Unsecured loans are not connected to collateral, meaning that if a borrower defaults on the loan, the lender does not become the owner of any property. Unsecured loans carry more risk for the lender because these loans are not connected to collateral. They also have higher interest rates and tend to be for smaller amounts. Student loans and personal loans are types of unsecured loans.

Credit Cards

Credit cards are a form of borrowed money that must be repaid. Individuals and companies can obtain credit cards from financial intuitions, companies, and retailers. Credit cards are unsecured, which makes them riskier for the lender. Because of this, some credit cards have high interest rates and low balance limits. If the balance on a credit card is not paid in full each month, interest is charged. The terms and conditions are different for every credit card, and each credit card carries different interest rates, limits, late charges, and fees.

Credit cards are a type of revolving credit. Revolving credit does not have to be paid back in a certain number of installments. Lenders are given a maximum limit they can use, and it is paid as long as it takes to pay off the debt. However, it is best to pay off credit cards in as few payments as possible to avoid paying large amounts of interest. Credit cards can help people build credit, but they can leave people with large debts if they do not pay them off in a timely manner.

In addition to regular credit cards, other types exist such as debit cards, prepaid cards, and charge cards. Debit cards, also called bank cards, differ from regular credit cards because they are connected to a person's bank account. When a person uses a debit card, the money for the purchase comes out of the person's bank account. Bank cards can be thought of as a different way of using cash, similar to checks.

Prepaid cards are paid prior to using them. A person pays an amount on the card, and then the amount is subtracted from the total on the card when it is used. A secured credit card is similar to a prepaid card. A person puts a deposit on the card, and the card's limit is based on the amount of the deposit. Secured credit cards typically have high interest rates and an annual fee, but they are used mainly to establish or repair credit. Charge cards are like regular credit cards, but they must be paid off in full every month. If people do not pay the balances on a charge card in full every month, they will be charged fees and penalties. This is to discourage the person from carrying a balance on a charge card.

Credit Report

The ability to obtain credit is based on a person's credit report. A credit report contains financial information about a person. It shows any loans or credit cards a person has, credit card limits and balances, and payment history. It also includes other debts such as service credit. Service credit refers to payments to utility providers such as electric, gas, telephone, and water companies. These payments must be made on time, or services could be terminated and fees applied.

Paying debts on time affects credit positively; not paying debts or not paying debts on time affects credit negatively. People should pay all debts on time to avoid paying late fees, which also can negatively affect their credit report. Based on the information shown on the credit report, a number known as a credit score is applied to a person. The credit score helps determine if a person is eligible for a credit card or loan. The higher the score, the better a person's credit is. Lenders are hesitant to loan money to people with poor credit scores.

Bibliography

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Yuille, Brigitte. "Credit Card Tutorial." Investopedia. Investopedia, LLC. Web. 16 Feb. 2016. http://www.investopedia.com/university/credit-cards/