Credit is a tool which allows you to borrow today with the promise to repay at a later date. However, Your Personal Financial Mentor advises you about the type of credit that is beneficial to you by keeping in mind the terms of credit, interest charges and principal repayments attached to it. Credit or debt is not free but it allows you to buy things when you need them without worrying about not having cash in your pocket. There are four basic types of credit.
Installment credit or installment loan – In this type of credit, you agree to borrow money with the promise to return it in equal installments over a specified period of time. Examples of installment credit or loan are personal loans, mortgages, automobile loan, land loan, construction loan and many more. Interest payments are included in the installments.
Revolving credit – In contrast to an installment credit, revolving credits are not paid back in a fixed number of installments. Instead, a lender approves a certain amount or a credit limit and you have ready access to your credit whenever you want it. However, you have to pay a certain amount on an outstanding balance.
Examples of revolving credit are credit card and line of credit. Line of credit is a source of credit that is offered to business, governments or entrepreneur by licensed consumer lenders and financial institutions such as banks. There are different kinds of line of credit, including export packing credit, demand loan, term loan, overdraft or O/D protection and purchase of commercial bills. The benefit of a line of credit is that it is available to borrowers at their discretion and interest is paid only when money is withdrawn. However, a small percentage fee is required to be paid for unused money or unused line on an annual basis.
Secured Credit – with this kind of credit, a debt is secured by collateral and the collateral is a type of item which possesses an equal or higher value than the amount of debt. Mortgages and home equity loans are the most common examples of secured credit. If a borrower defaults on repayment, lender such as financial institutions like banks seizes the collateral that was secured against the debt.
Unsecured credit – these credits are not backed by any collateral and are based on a creditworthiness of a borrower. The creditworthiness of a borrower is assessed through the credit scoring system and through his ability to repay. If a borrower is unable to pay back the debt, the lender usually turns the account over to a collection agency which collects the debt on behalf of the lender. Interest rates are usually high on unsecured credit as compared to secured debt which has lower interest rates because of the collateral attached to it.