As you prepare to begin a new year, this is a great opportunity to get “Back to Basics” in regards to your credit and finances. If you have the luxury of time off from work or your regular routine, devote a small portion of this time or any free time you may have to a type of financial re-calibration. Investing just a little time in making sure you are knowledgeable in the areas that will affect your economic future is wise and here is a great place to start!
Accounts on your credit report fall into six major categories. They are Installment, Revolving, Open, Secured, and Unsecured credit. These categories often have overlapping features. Having LuxuriousCREDIT starts with being knowledgeable about what credit is and how it is best used. This list will help you identify the types of credit you may already be using as well as make responsible and informed decisions about borrowing in the future.
Installment credit is extended with the understanding that what is borrowed will be repaid in equal amounts over an established length of time. This type of credit is most commonly used for large purchases like a car loan, mortgage, or student loan. In these cases interest is often charged at a fixed rate and is calculated as part of the loan. Each payment is known as an installment, hence the name “Installment”credit.
Example of Installment Credit:
Stephen signs a contract for an auto loan in which he agrees to pay the lender $350 per month for the next four years.
Revolving credit allows the borrower to spend up to a pre-established amount as long as the account remains in good standing. The balance must be paid, all or in part, monthly. The unpaid portion of the balance will be subject to interest and remains unavailable until the lender receives payment. Any portion of the pre-established limit that is paid becomes available once again. Credit cards and home equity loans are good examples of revolving credit. This pattern of spending and re-payment goes around and around somewhat like a revolving door, hence the name “Revolving” credit.
Example of Revolving Credit:
Chris applies for a credit card and is approved! She uses the card to make purchases and, at the end of the month, receives a bill. At this point Chris can choose to pay off the balance in full or just pay the minimum monthly payment, which typically covers interest and a small portion of the balance.
Open credit has no limit. The borrower can spend as much as they want or need to as long as the balance is paid, in full, each month. Corporate credit cards as well as America Express are well known for offering this type of credit.
Example of Open Credit:
Joy travels for work and uses her corporate credit card to pay for all her travel expenses while she’s away. Each month, she submits a payment request to her company’s finance department. They, in turn, pay the entire balance of the card at once.
Secured credit is a line of credit that uses some type of collateral to guarantee repayment. By placing a lien on a piece of property, car, or other asset the lienholder withholds the right to poses these assets if the terms of the loan are not honored. The lien allows for an increased measure of security and heavily discourages default or non-repayment, hence the name “Secured” credit.
Unsecured credit lines are extended to borrowers with a proven history of financial responsibility. This type of credit is not linked to any assets and therefore does not require collateral. Utility bills, credit cards, and medical bills are all examples of “Unsecured” credit.
Real Estate credit is a line of credit specifically connected to a piece of property, usually a home. This line of credit can be secured or unsecured. For secured lines of real estate credit, in the event of non-repayment ownership of the property is transferred to the lender. An unsecured line of real estate credit is established based on the creditworthiness of the borrower.
Examples of Secured, Unsecure, and Real Estate Credit:
Joseph purchases investment property A using an unsecured home loan. He uses this loan to cover repairs and rehabilitation on the home. Prior to the re-sale of property A, however, he discovers property B, which he would also like to invest in. Joe decides to use the equity in property C, which he also owns, as a secured line of credit for the purchase of property B.
Needless to say, Joe has LuxuriousCREDIT, an eye for a deal, and knows how to make smart and savvy decisions about how to best optimize his credit and his money. These are simply the fundamentals of financial literacy. Getting familiar with these principles is a great start towards the bigger and better financial milestones you desire.