Types of Credit and Advice
Whether used in the form of a mortgage, car loan or a little plastic card, credit deserves significantly more attention than most people give it. Thankfully, this seemingly complex topic can be sectioned out by category and peeled open to reveal all of the secrets bankers like to keep to themselves.
General Types of credit
There are two main categories of credit, secured and unsecured. Each of these has several more options with a wide range of applications.
Unsecured Credit
Unsecured debt simply refers to the good faith a borrower extends to the lender that the debt will be repaid. In the event of a default, with unsecured debt, the lender cannot simply take possession of a valuable piece of property to reclaim losses. This does not mean unsecured debt can simply be ignored. Failing to pay on a credit account can result in being sued by the bank, bankruptcy and wage garnishment. Credit is a powerful tool, but it must be used responsibly.
By far, the most common form of unsecured credit available is a credit card account, which is a type of revolving credit. With revolving credit, an account is created with a maximum credit limit. A person can continuously borrow against this limit, and pay down the balance on this account, for as long as the account remains in good standing.
Secured Credit
When credit is designated as secured, this simply means the debtor has committed collateral against the loan. If the person using the secured credit, the debtor, fails to make good on the promise to repay the loan, the bank or lender issuing the credit will take possession of the property used to secure the loan. This process varies by the type of loan and local laws. Regardless of the mechanism for default, the important thing to take away from any study of secured debt, is that anything purchased with it can be lost if the loan is not paid off.
Secured credit is commonly used as loans for cars and homes. Businesses may use credit secured against assets, such as real estate or equipment. Most secured credit is structured as a fixed term loan. In this arrangement, a loan for a specific amount of money is created. A fixed term for this loan is defined, such as 30 years paid monthly for a house or five years paid monthly for a car. When the loan is paid off, the account is closed.
Choosing a Lender
Credit is a product that lenders offer for people to purchase. They are trying to sell this product. The cost of the purchase comes in the form of interest, and while it is not always easily viewed, it is very real.
Interest is of course not the only cost when considering credit. A balance transfer credit card may charge an up-front percentage of the balance transferred, and a home mortgage will almost always come with a large list of fees, either listed separately, or built in through interest and points adjustments.
Choosing a lender is often a matter of finding the best deal when all costs are considered. For things like credit cards, there are only a couple of items to consider. For more complex credit, like a car or home loan, there may be many factors in play. The best approach is usually to just list out the costs, and build a comparison between lenders. For example, when buying a car, look at the total cost structure.
- What is the total amount financed?
- Where any fees rolled into the loan principal?
- What is the interest rate?
- How long is the payment term?
- What is the total amount of payments made over the course of the loan?
When shopping for credit, comparing products offered from various sources, and understanding the costs involved, will give a person a significant advantage when it comes time to negotiate terms. From a fundamental understanding of the types of credit described here, to the detailed understanding of an interest calculation, information is a powerful tool for a credit seeking consumer.