Credit is a wide-reaching topic.
If you can answer the question “what is credit?“, you’re ready to explore it further.
When people think of the types of credit, however, most jump right to credit cards.
It, in fact, comes in many forms, with many characteristics, and from many sources.
Each type of credit comes with different payment structures, acquisition requirements and usage rules.
There’s only one thing each type of credit has universally in common with the others:
Every form of credit is a loan requiring repayment.
It may sound like a complicated and confusing issue, but fear not, as you read on you will gain a much better understanding of all that stuff.
The journey begins with:
Also known as revolving credit, this type of credit features a fixed credit limit with free access to the available credit with payments varying based on the outstanding amount borrowed.
You can think of revolving debt like a revolving door: as the door revolves, people can both enter and exit at the same time.
This is exactly how revolving credit works.
As the billing cycle moves along (revolves), you can use up portions of the available credit and at the same time repay the amounts used.
Generally, this is done once time after the statement cycle ends, but payments can also be made during the cycle without waiting.
This is a perpetual cycle of borrowing and repayments, with no set end until one of the parties makes the choice to close the account.
Examples of revolving credit
- Credit Cards
- Charge Cards*
- Home Equity Lines Of Credit (HELOC)
*Charge cards are becoming more like credit cards these days. American Express, for instance, allows certain purchases to be paid off over time, and most retail charge cards do allow for revolving balances.
Also known as installment credit, or installment accounts, these types of accounts feature a singular loan amount requiring fixed repayment amounts.
Keeping in line with the example above, you can think of this type of credit as a hinged door: generally, there is a directional flow of traffic.
Looking at non-revolving credit in this way, you borrow a fixed amount and that is all, and as time passes, all of the transactions flow one way: back into the account to pay for the amounts loaned to you in the original transaction.
There is no access to additional credit, and once the account is paid off, it is closed.
Examples of installment credit
- Auto Loans
- Student Loans
- Appliance Financing
The types of account which fall into this category are generally required to be paid in full at the end of the billing cycle.
These are generally associated with utility bills.
They don’t have pay-over-time options like revolving credit lines, or charge interest for unpaid balances.
Instead, these types of accounts charge late payment penalties, and will simply turn off service if the account is delinquent for an extended period of time.
Examples of open credit
- Cellular Telephone
- Cable & Internet
Now that you know what the different classifications of credit are, there’s another layer to this puzzle that you need to be aware of.
While it’s not overly complicated, it is important to understand these two distinctions about the types of credit.
Any time you have to put up something tangible as collateral in exchange for a line of credit, that is considered to be a secured line of credit.
They are pretty much all of the credit options you can get through a financial institution such as a bank or credit union.
If you should fail to hold up your end of the deal, the lender will be able to take possession of the collateral you used in order to satisfy the debt arrangement.
Secured credit arrangements are viewed as safer for the lender, as they have the benefit of knowing that the asset will transfer ownership upon default, which minimizes the lender’s loss.
It’s also safer because most people will work harder to keep current on credit arrangements under which they stand to physically lose something.
This perceived safety can lead to lower interest rates for the borrower.
Examples of secured credit
- Home Equity Line of Credit (HELOC)
- Auto loans
- Secured credit cards
- Some personal loans**
- Some utilities**
Conversely, any credit arrangement that does not require the posting of collateral is called unsecured credit.
This type of arrangement is based on common factors like the borrower’s credit history and their financial standing.
Because there is no collateral, this type of credit generally comes with higher interest rates.
And, because there is nothing securing the credit, borrowers who are in default risk their accounts being sold off to debt collectors and subsequently the potential to be sued.
Examples of unsecured credit
- Credit cards
- Charge cards
- Student loans
- Some utilities**
- Some personal loans**
**Utilities and personal loans can fall into either category. If a review of the individual’s credit history signals higher-than-normal risk, a deposit is usually required designating that account a secured line of credit. Otherwise, no backing needed, leaving the account an unsecured line of credit.
This should give you a pretty solid basis for understanding the different types of credit that are available to you.
Like any tool (and credit is just that–a tool), however, you need to know more than the basics to use it properly.
Keep learning and educating on all things credit to keep yourself financially healthy!
Questions For You
When you first started out using credit were you aware of all this info? If you are new to credit, does knowing this make you feel more confident or less moving forward?