The three main types of credit are revolving credit, installment credit, and open credit. Credit allows individuals to purchase goods or services now and pay for them later using borrowed money. The lender charges interest for this service.
Types of Credit Explained
Here's a more detailed breakdown of each type:
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Revolving Credit: This type of credit has a credit limit that you can borrow against repeatedly. As you pay down the balance, the available credit replenishes. Credit cards are the most common example of revolving credit. Other examples include lines of credit. The key feature is the flexible repayment schedule, where you can choose to pay the minimum amount due, a larger amount, or the full balance each month. Interest is charged on the outstanding balance.
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Installment Credit: This type of credit involves borrowing a fixed amount of money and repaying it in regular, fixed installments over a specific period. Each payment typically includes both principal (the amount borrowed) and interest. Examples of installment loans include auto loans, mortgages, and personal loans. Unlike revolving credit, the available credit does not replenish as you make payments.
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Open Credit: Also known as service credit, open credit is typically used for short-term needs and requires full payment at the end of each billing cycle. Utility bills (electricity, gas, water) and some charge cards (like American Express cards where you must pay the balance in full each month) are examples of open credit. There is typically no interest charged if the balance is paid in full on time. However, late payments can result in fees or penalties.
| Type of Credit | Description | Examples | Repayment |
|---|---|---|---|
| Revolving | Credit limit that replenishes as you pay; flexible repayment. | Credit cards, lines of credit | Minimum payment due monthly; interest charged on outstanding balance. |
| Installment | Fixed amount borrowed; repaid in fixed installments over a set period. | Auto loans, mortgages, personal loans | Fixed monthly payments including principal and interest. |
| Open | Short-term credit requiring full payment each billing cycle. | Utility bills, some charge cards (American Express) | Full balance due each month; failure to pay on time may result in fees/penalties. |
Understanding the different types of credit is essential for managing your finances responsibly and making informed borrowing decisions.
