What is credit? 4 common types explained
We hear the word credit used often when it comes to money and personal finance, but what exactly is credit? Credit can be simply defined as an agreement between a borrower and lender, in which the lender will provide a given amount of money to the borrower, which is usually paid back with interest. This money borrowed can be used for goods or services, especially emergency situations. There are different types of credit known as revolving credit, charge credit cards, service credit, and installment credit. Read on for more about the different types of credit.
1. Revolving credit– A majority of credit cards can be referred to as revolving credit. The borrower is given a set amount line of credit, which offers a maximum amount the borrower can use. Charges can be made up to this maximum amount. Whatever you spend through revolving credit, also known as your balance, will be carried over each month. There will be a minimum payment which must be made each month (although it is recommended to pay off the full balance to better your credit). Revolving credit involves interest, which differs based on the credit card, your credit score, and other factors.
2. Charge cards– Other types of credit cards, known as charge cards, are similar to revolving credit. The borrower is given a maximum amount of credit to be used for whatever they need. However, with charge cards the total balance must be paid every month. For this reason, charge cards tend to be made available for people with excellent credit, and many offer reward incentives for using a charge card.
3. Service credit– Companies provide services to individuals for many different things. Your electricity, gas, and cable providers all deliver their services to the consumer, who agrees to pay for that service. This is mostly paid on a month to month basis, but can be different based on arrangements with the provider. It is important to note, that service credit does not always show up on your credit report. You might want to check first with your provider if you are trying to improve your credit score.
4. Installment credit– This is a popular form of credit, which can also be referred to as a common loan. The borrower loans out a specific amount of money, which is to be paid back with interest. This payback period can be made through monthly installments or can be a fixed amount paid over a determined period of time. Some of the most popular types of installment credit are home mortgages, auto loans, and personal loans. Installment credit does get reported to the three major credit bureaus, so it is important to stay on top of payments.
Borrowing money one way or another is inevitable, but it doesn’t have to be confusing.
Understanding what credit is and the different types of credit can really aid in the development of a successful financial future when it comes to your own personal credit.