Types of Credit

Each type of credit has its own purpose and features. Understanding the different kinds of credit can improve your credit behavior and empower you to make informed financial decisions.

Let’s review the major types of credit you might encounter, along with the key elements of each. Personal loans, for instance, are often unsecured loans that can be used for a variety of purposes, and understanding their role in your financial portfolio is important.

Revolving credit

The most common type of credit is revolving credit. Revolving credit lines allow you to keep using the credit even if there is a balance.

With revolving credit, there is a set credit limit you cannot exceed. If you do go past the limit, your card would be declined and you might be charged extra fees.

Revolving credit often has high interest rates and annual percentage rates (APRs). Although repayment terms are often flexible with fairly low minimum payments, the high APR can lead to an unexpected increase in debt if you are not diligently paying down your credit balance.

Credit cards

Credit cards are thin cards of metal or plastic that are issued by financial institutions to cardholders. You can use your credit card to pay for goods and services as long as the merchant accepts credit cards. In today’s day and age, credit cards are ubiquitously used as a payment method.

Some of the most well-known credit card companies include Visa, MasterCard, and American Express.

Lines of credit

A line of credit is a flexible, revolving loan that lets you borrow money, repay it, and borrow more. Interest will accrue on any amount of credit that you’ve used and haven’t paid back yet.

As long as you don’t exceed the credit limit that you agreed to, you should be able to access funds from your line of credit.

Home equity lines of credit (HELOCs)

A home equity line of credit is revolving credit that lets you borrow against the available equity in your home. It is similar to a credit card in that there is a limited amount of credit you can use (your available equity), but as you pay down the balance, your credit will be replenished and you will be able to borrow more against your home equity.

In HELOCs, your home is used as collateral to secure the line of credit.

Installment credit

Installment credit gives you access to funds, but you have to repay the amount plus interest over time with a set repayment term.

Installment loans include mortgages, student loans, auto loans, and personal loans. You are expected to make regular, on-time payments in the form of installments until the debt is fully paid off.

If you miss an installment and don’t make the payment before the grace period ends, you may be charged late fees and your credit score can take a hit.

Installment loans can help you finance large purchases or provide you with emergency funds. You will typically be given anything from 12 months to 60 months to repay the loan amount plus interest. The flexibility of installment loans gives borrowers a lot of freedom in how they want to use the loan funds.

Secured credit

Secured credit is another way to refer to credit that is backed by something of value–collateral assets. The most common secured credit types are mortgages, auto loans, and secured credit cards.

A major benefit of secured credit is that it allows borrowers who need large loan amounts and/or have a low credit score to obtain the loan funds that they need. Using collateral to back the line of credit can give you plenty of flexibility and opportunity.

Secured credit can be a good way for you to establish or improve your credit. As long as you are able to pay the refundable deposit to back your new account with collateral, secured credit can bring you significant value and convenience.

The downside to secured credit cards and loans is that you might encounter high APRs, low limits or funds, and the risk of losing your collateral assets.

Mortgages

Mortgages are loans that help people buy property. They are backed by collateral, which in nearly all cases will be the property that the loan funds are used to afford.

The average mortgage homebuyers take out is $220,000. Mortgage loan tenures are commonly 10, 15, 20, 25, or 30 years. However, many people will choose a reduced loan tenure of one decade to decrease the time spent in debt.

Auto loan

Auto loans are used to finance the purchases of used and new vehicles. The collateral you use when applying for an auto loan is often the car that you’re trying to buy. However, if you want to use another asset as collateral, this is also possible.

If you miss too many payments or default on your loan, the lender will be able to seize your collateral, causing you to lose the car you purchased with the loan.

Secured credit cards

A secured credit card is a special kind of card that requires you to make a cash deposit, otherwise, you won’t be able to open the credit card account. This cash deposit counts as the collateral that backs the credit card.

Many people are satisfied with their secured credit cards, but if you’re hoping to obtain an unsecured credit card one day, obtaining a secured one is a good way to work your way up to your goal.

Unsecured credit

Unsecured credit does not require collateral. Because of this, borrowers will need to have higher credit scores to convince lenders that they are creditworthy. When people say “credit card”, they are most likely referring to unsecured credit cards.

Unsecured credit may also be used in reference to unsecured personal loans. These loans typically have more stringent terms and conditions. They require borrowers to have an acceptable credit score and the interest rates can be quite high if you have poor credit.

Open credit

A line of credit can be either open-ended or closed-ended. Open-end credit doesn’t impose restrictions upon what you can use the credit for. Examples of open credit include credit card accounts and debit card accounts. With open-end credit, you are expected to make payments regularly and get rid of the outstanding account balance (either in full or over the course of a predetermined period).

Advantages of open-end credit

Flexibility: The lack of restrictions means that you get a lot of flexibility and freedom in how you use your credit. Whether that means buying day-to-day necessities, paying for entertainment, or dealing with emergency expenses, open-end credit is a great way to help you meet your goals and needs.

Accessibility: Open-end credit lets you access the line of credit and draw money from it even if you haven’t completely paid off the outstanding balance.

Convenient: Most lines of open-end credit offer you convenient ways to make payments, whether that is in-person or online. For example, debit cards and credit cards are easy to carry with you when you are shopping, and most merchants will accept them as payment methods when you make purchases online.

Disadvantages of open-end credit

Set limit: You cannot go over the pre-approved credit limit. If you do, your credit card will get declined and you might need to pay an over-limit fee.

High interest rates: Open-end credit is notorious for having high interest rates and high annual APRs. If you fail to make payments on time before the grace period is over, debt can quickly accrue. Because of this, it is critical to make sure that you are paying down the balance as much as you comfortably can every month.

Temptation to spend money you don’t have: Credit accounts that are open-ended often tempt people into making large purchases that are only possible with the use of open-end credit. These impulse purchases that exceed your realistic budget may lead to a debt burden that you cannot easily pay off later on.

Potential credit impact: If you cannot effectively manage your open-end credit account, it is easy to cause dips in your credit that can add up over time. Open-end credit means you will need to carefully manage your credit balance and credit utilization so that you don’t hurt your credit score too much.

Closed credit

Closed-end credit gives you a lump sum of money to use, usually for a specific purpose. When you apply for closed-end credit, your lender may ask you what you intend to do with the funds. Common uses for closed-end loans include financing a car, a home, or a project.

Advantages of closed-end credit

Clear structure: Because closed-end credit comes with a set, predetermined repayment schedule, it offers you clear structure.

Simplifies end use: Closed-end credit is meant for specific purposes depending on what credit or loan you’ve applied for. This strong sense of direction can simplify the way you spend and prevent you from mismanaging your funds.

Predictable payments: Closed-end credit is associated with fixed interest rates. This makes it easier for people to budget for any monthly payments since the repayment plan is so predictable.

Disadvantages of closed-end credit

Lack of flexibility: Closed-end credit doesn’t give you much freedom when it comes to loan tenure, repayment terms, and additional borrowing.

May require collateral: Depending on what closed-end credit you’re seeking, you might need to put up assets as collateral. For secured closed-end personal loans, if you default on your loan payments, lenders would be able to repossess this collateral, causing you to lose your valuable assets.

Fixed amount: When your closed-end credit application is accepted, the lender will disburse funds into your account. If you want to increase the amount of funds that are credited into your account, you will usually have to re-apply for a new loan.

Single-payment credit

Single-payment credit is a kind of arrangement where the borrower is expected to repay the creditor with the money that was disbursed to them in a short period of time. Common examples of single-payment credit include:

• Payday loans
• Title loans
• Cash advances
• Pawn shop loans

The benefit of single-payment credit is that it can help you out in a pinch if you need money urgently to deal with expenses that you couldn’t otherwise afford. However, single-payment credit often comes with high interest rates and fees. If you cannot repay the full amount in a single payment by the due date, you can lose any assets you put up as collateral and be charged numerous expensive fees.

Multi-payment credit

Unlike single-payment credit, multi-payment credit is more lenient when it comes to how long you have to repay the loan or pay off the balance. You don’t need to pay off your balance or debt in a single go. Instead, you can pay everything off in many installments.

The term is typically predetermined and gives you plenty of time to budget for credit repayment. Multi-payment personal loans often have loan tenures between 36 and 72 months.

Service credit

Also called “utility credit”, service credit is a kind of open credit that lets you open an account for various services, such as gas, electricity, or internet. The benefit of service credit is that it lets you maintain the use of your utilities without needing to pay everything off immediately.

The amount that is due each month will show up on your service credit account’s remaining balance. This amount can vary each month due to fluctuating use of data, heat, gas, electricity, or whatever service the account is for.

Retail credit

Retail credit is offered by many retailers that are willing to extend credit to their customers. Many people who shop at retail stores have been asked whether they are interested in applying for the brand’s own credit card.

Retail credit often comes with:

• Store-branded credit cards
• Loyalty programs
• Limited usability restricted to the retailer of choice’s network
• Special promotions
• Deferred payment options
• Discounts and rewards

Due to the many promotions and special rewards, retail credit can be an attractive option for those who often shop at a particular store.

However, it’s a good idea to review the terms and fees of each retail credit option. It can be risky to sign up for too many different retail credit cards because they may lead to unnecessary debt and accrued interest that you can easily forget about.

About The Author

Ru Chen

Content Writer

Ru Chen is a content writer with several years of experience in creating engaging and well-researched articles. She mostly writes about business, digital marketing, and law. In her free time, she can be found watching horror movies and playing board games with her partner in Brooklyn.

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