What is Credit?

What is Credit? background

Credit involves a promise to pay in the future for purchases made today. It comes in the form of either a loan or line of credit. A loan typically offers a set term or payment period, a fixed or variable interest rate and set monthly payments. A loan is generally used when credit is extended for a car or home. The full amount is extended at the time the loan is closed.

A line of credit offers you the ability to access cash at any time, generally in any amount up to the credit limit, with the promise to pay the money back plus interest, according to preset terms. With a line of credit, the interest is generally variable and will change based on market conditions. Payments will change each month based on the outstanding balance. The term is flexible because a payoff is not guaranteed. The line can be reused as money is paid back. Credit cards and home equity lines are common forms of lines of credit.

All credit involves a lender who pays for the goods or services in exchange for your promise to pay them back under the agreed terms. When you get a car loan, the bank pays the dealer for the car, and you make payments to the bank, plus interest, to pay the loan off. During the repayment period the lender will hold title to the vehicle and when it is paid in full, the lender will send you the title and you will own the vehicle free and clear. This process is used for all collateral loans involving titles. A home involves a deed, which operates under the same principle, though generally the borrower holds the deed and the lender maintains a lien, securing the property as collateral for the loan.

Lines of credit are issued with a specific credit limit. The lender (bank) can set and change that limit based on their lending criteria and your credit worthiness. As the card holder, you have access to this line of credit as you see fit. You can make large or small payments to reduce the balance and can re-borrow from the line, as long as the account is in good standing. A credit card line is considered a revolving line of credit.

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