Credit 101: Most Commonly Used Types of 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.

  • 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.

    PROS

  • Allows you to purchase needed products and services now and pay for them over time (i.e. higher education, car, home).
  • More convenient than cash for some reservations (i.e. airline, hotel, car rental) and purchases.
  • Safer than carrying cash.
  • Useful in case of short-term emergencies (i.e. car repair).
  • May provide you with desirable benefits (purchase protection, travel insurance, frequent flier miles, cash back bonuses, etc.)
  • Helps establish a credit history.
    CONS

  • Interest and fees can be considerable.
  • Easy access to money presents a temptation to overspend & abuse your credit privilege; thereby, committing too much future income to credit payments.
  • If credit card accounts are not paid as agreed, then your credit history will be negatively impacted for a number of years after the event. This could affect your future applications for mortgages, other installment loans, or other credit related applications.
  • Available credit may offer a false sense of security and may be thought of as emergency “savings” or a source of income.
  • Expense of using credit may outweigh the perks (i.e. purchase protection, travel insurance, frequent flier miles, cash back bonuses, etc.).

Find out how to shop for credit