Sunday, February 1, 2009

What exactly is credit

Credit is a contract in which you promise to pay in the future for goods, services, or money received today. Forms of credit backed by collateral (money or property you put up as a guarantee you will repay) are secured. If you do not repay as agreed, the lender will be able to repossess the collateral. Car loans and mortgages are examples of secured loans. Most credit and charge cards are unsecured, but there are some secured cards available for those who cannot qualify for an unsecured card. For example:

Debit card - allows you to access funds in your checking or savings account. It is accepted wherever the logo on the card is displayed. This is not a loan and using it does not establish a credit history.

Credit card (revolving account) - allows you to make purchases or take cash advances and pay back a portion of the balance you owe each month with interest. The minimum payment due is usually a percentage of the outstanding balance, typically 2 – 3%. Most credit cards charge other fees (i.e. cash advance fee, late payment fee, annual fee) in addition to interest.

Charge card (open-ended account) - allows you to purchase items or take cash advances and requires you to pay the entire balance in full each month. No interest will accrue if the balance is paid as agreed, but there is often an annual fee. Other fees may also apply (late fees, cash advance fees, etc.).

Installment Loan (close-ended account) - allows you to borrow the money you need up front (usually for a specific purchase such as a car, education, home, etc.) and then repay it over a specified period of time with interest. The payment is usually the same amount every month.

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