Types of Credit: Closed or Open-End

April 13, 2006

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Consumer credit falls into two broad categories: closed-end and open-end.

Closed-end credit is used for a specific purpose, for a specific amount, and for a specific period of time. Payments are usually of equal amounts. Mortgage loans and automobile loans are examples of closed-end credit. An agreement, or contract, lists the repayment terms, such as the number of payments, the payment amount, and how much the credit will cost. Generally, with closed-end credit, the seller holds legal ownership (title) to the goods until all payments have been completed.

With open-end, or revolving credit, loans are made on a continuous basis, and you are billed periodically to make at least partial payment. Using a credit card issued by a store, a bank card such as VISA or MasterCard, or overdraft protection are examples of open-end credit. There is a maximum amount of credit that you can use, called your line of credit. You have to pay interest or other kinds of finance charges for the use of credit.

Revolving check credit is a type of open-end credit extended by banks. It is a prearranged loan for a specific amount that you can use by writing a special check. Repayment is made in installments over a set period, and the finance charges are based on the amount of credit used during the month and on the outstanding balance.
Charge cards are issued by department stores and oil companies and, ordinarily, can be used only to buy products from the company that issued that card. You pay your balance at your own pace, with interest.
Credit cards also called bank cards are issued by financial institutions. Credit cards provide prompt and convenient access to short-term loans. You borrow up to a set amount, pay back the loan at your own pace--provided you pay the minimum due--and pay interest on what you owe. Whatever amount you repay becomes immediately available to reuse. VISA, MasterCard, Optima, and Discover are credit cards.

Did You Know?

The vast majority of financial institutions are affiliated with VISA International or the Interbank Card Association, which issues MasterCard. A bank credit card differs from other credit cards in that it is issued by a bank, and as you make purchases using the card, you are instructing the bank to pay the merchant immediately. You then reimburse the bank .

Travel and Entertainment (T&E) cards require that you pay in full each month, but they do not charge interest. American Express, Diners Club and Carte Blanche are T&E cards.
Debit cards are issued by many banks and work like a check. When you buy something, the cost is electronically deducted (debited) from your bank account and deposited into the seller's account. Strictly speaking, they are not "credit" because you pay immediately (or as quickly as funds can be transferred electronically).

Also, debt can be secured or unsecured. Your loan is secured when you put up security or collateral to guarantee it. The lender can sell the collateral if you fail to repay. Car loans and home loans are the most common types of secured loans. An unsecured loan is made solely on your promise to repay.

If the lender thinks you are a good risk, nothing but your signature is required. However, the lender may require a co-signer, who promises to repay if you don't. Since unsecured loans pose a bigger risk for lenders, they have higher interest rates and stricter conditions. If you do not repay an unsecured debt, the lender can sue and obtain a legal judgment against you. Depending upon your state's rules, the lender may then be able to force you to sell other assets to pay the judgment or, if you are employed by another, to garnish a portion of your wages.