These days, it is quite common for anyone to obtain car loans, mortgages, home equity credit lines, or credit cards. We all take out loans so that we can purchase certain items. Some people are successful at handling their credit, while there are also others who are unfortunate as they fall into debt.
There are various kinds of credit available, and it is a wise move for any consumer to understand the basics of these credit types. If the type of credit you have requires you to pay it in full by the end of a specified date or a term, it is a closed-end credit. When repaying this type of credit, which is also known as a secured loan or an installment loan, you need to include the agreed interest and if available, the financial charges.
There are times when you apply for closed-end credit that it is designed for a specific purpose. An example is a real estate or car loan where you are allowed to borrow a specific amount of money with a specific repayment schedule. It is significant that you repay the amount as well as the interest involved and other financial charges punctually every month. After you have repaid the loan, it signals the closing of the account.
The Requirements to Qualify for a Closed-End Credit
For a consumer to qualify for a closed-end credit, he or she should meet the requirements, which will depend on the lender. However, there are some typical conditions, which often include the following:
Often, the lender or creditor will require an individual to provide collateral, which is to guarantee or secure the loan. Examples of commonly used collateral are the consumer’s home or any real estate property to be used as security for a home equity loan or mortgage. Meanwhile, the car being purchased is typically the collateral for the auto loan. Note that the collateral should meet the standards of the lender when it comes to the value of the loan.
The Ability of the Person to Repay the Loan
One of the most important qualifications for mostly any loan, including closed-end credit is the person’s ability to repay the loan. For the lender to know whether or not the borrower is capable of paying the amount, an assessment is often made particularly on the income of the borrower. Monthly bills are often also examined to determine if the applicant has the potential to keep up with the periodic loan payments.
Other considerations include the current credit score, credit history, and net worth of the borrower. Those with good credit history, high credit score, and substantial existing asset are viewed as low-risk borrowers, so they have a better chance of getting approved for the loan.
Are There Risks Involved in Closed-End Credit?
Compared to open-end credit, there are quite a few advantages when you get approved for a closed-end credit. In general, it is quite easy to obtain, especially if your credit history is in good standing and you meet the requirements of the lender. It is also a good way for you to establish a good credit score. When you are approved for the loan, it is a demonstration that you are credit-worthy. You can use this to your advantage if you want to apply for another loan in the future.
However, whenever money is involved, there are always risks. When it comes to closed-end credit, the interest rates are much lower than the interest rates on open-end credit. The problem here is that the interest accrues daily, so your outstanding balance grows each day. Most closed-end credit loans come with fixed interest rates, but some types such as mortgage loans can have a variable interest.
Another issue with closed-end credit is that there are lenders who charge prepayment penalties, particularly if the loan is paid prior to the agreed upon due date. Most lenders, however, charge penalty fees if the payments are late and the fees will depend on the assessed value of the organization.
Perhaps the biggest problem is that there is collateral with closed-end credits. If the borrower defaults on the payments for his or her loan, the lender has the right to repossess the property, car, or any collateral involved in the process. Therefore if you used your home as the collateral and you did not repay your loan on time, your lender could seize that property.
Finally, another risk with closed-end credit comes with a longer loan term. While you may have plenty of time to pay for your loan, this also means there are higher interest charges to pay over time. Some loans, such as mortgage and auto loans would require you to wait before the lender transfers the ownership to you until you have paid for the loan in full.
Closed-End Credit vs. Open-End Credit
Another type of credit that is mentioned above is open-end credit. This credit type, unlike closed-end credit, does not have a specific duration or use. Among the popular examples of open-end are credit card accounts, debit cards, and home equity lines of credit. When a bank or lender allows a person to get this type of credit, he or she can utilize the funds borrowed in exchange for just the promise of repaying the debt on time.
In open-end, you are not required to repay your debt at a set date. Instead, you are given a maximum amount that you can borrow. Often though, this amount can be revised. However, you are required to make monthly payments, and the amount will be based on the credit you used.
When it comes to borrowing limits, both closed-end and open-end have them as imposed by the bank or the lender for their protection – and yours as well. The limit will usually be based on your credit score whether or not the credit line is secured.
To understand better, here is an example: you take a home equity line of credit, which is a secured credit line. Your home is the collateral, and it is a valuable property. In this case, your credit line will be huge. It is a requirement that you own that property in order for you to use the credit. On the other hand, a credit card, which is an unsecured credit line, will provide you with a smaller borrowing limit because you do not have to provide collateral.
Here are some examples to understand the difference between closed-end and open-end credit lines:
Open-end credit lines are required to be paid monthly as long as the borrower has credit, along with an outstanding balance. Therefore, you can use a credit card for five years or even more to pay off purchases and make other kinds of payments on condition that you pay the credit card bill every month.
A student is given a loan of $10,000, and the interest is $2,000. If the student is required to make payments in 10 years, he or she will have to pay $100 monthly.
Another important difference between these two credit lines is how they affect the credit score of the borrower. Your credit score can increase with the help of both credit lines, especially if you make payments on time.
However, with open-end, the amount of available credit can be increased, which can lead to increased credit score. Meanwhile, closed-end credit disperses your credits immediately, so they are seen as outstanding debt, which may result to lower credit score. Still, obtaining a closed-end credit is viewed as one of the best ways to build a good credit score.
Examples of Closed-End Credit Types
The most frequently applied for closed-end credit loans are car loans and mortgage lending. These two types of loans are taken out for a specified amount of time in which the consumer is required to pay regularly. An example is a 15-year mortgage of $200,000 and has an interest rate of 3.4%. After 15 years of making monthly payments, both the loan and the interest are fully paid by the borrower.
There are three common types of this loan, which are the following:
Installment sales credit: This type of closed-end credit has a fixed number of required payments to make.
Installment cash credit: In this type, a purpose is involved in borrowing money. Typically, it is for a personal purpose, vacation expenses, or home improvement. The borrower is not required to make a down payment, but you need to make payments in certain amounts for a set period.
Single lump sum credit: The third type of closed-end credit involves a loan that the borrower should repay in full over a specific day. More often than not, the loan should be paid within 30 up to 90 days. Though not always, single lump sum credit generally involves the purchase of one particular item.
In the case of a mortgage loan, the total amount to be paid is often divided into installments that should be paid monthly. Typically though, the borrower should pay not only the principal amount but also the interest. After the borrower makes the last repayment, the ownership of the property will be transferred to him or her.
As for auto loans, there is a fixed period during which the borrower should be able to make repayments. The amount to be paid also includes the interest, and the car title is transferred only after the time the borrower can make the full payment. Auto loans though are much shorter than mortgage loans, and most of them have fixed interest rates.
Personal Uses of Closed-End Credit
Individuals often use mortgage and auto loans. Some people choose to apply for a closed-end credit to purchase items they cannot afford to make a full payment of, such as a house, furniture, or a vehicle. The loan can also be used to pay for a trip to another country or vacation packages. Whatever it is, the borrower is usually required by the lender to disclose the reason why he or she is applying for the loan.
Business Uses of Closed-End Credit
Just like with individual borrowers, mortgage and auto loans are the most used types of closed-end credit by businesses. Often, the credit is used to finance expensive purchases, including vehicles, properties, and necessary equipment. The same process is involved whether the applicant is a company or an individual borrower.
For instance, if the company needs to purchase delivery vehicles, the closed-end credit can help finance the acquisition. There will be an interest rate, and the loan should be paid monthly using the minimum amount, along with interest for a specified amount of time. If the company defaults on the repayments, the lender can seize the purchased vehicles.
Once you have signed the agreement, the closed-end credit can no longer be changed. If you need to make a big ticket purchase, a structured loan in the form of closed-end credit can help you.