Whether purchasing a car, a television, or a restaurant meal, Americans often use credit to help pay for goods or services. Understanding the types of credit and their costs can help consumers use credit wisely.
Consumer credit falls into three general categories. Open-end credit allows a person to charge purchases, but the creditor expects full payment within 30 days. Local businesses and travel and entertainment cards like American Express offer open-end credit.
Revolving credit allows a consumer to pay all, part or a minimum amount of the outstanding balance each month. Any unpaid amount revolves to the next month's balance and incurs a finance charge, or the cost for the consumer to owe that money for 30 more days. Credit cards issued by banks, oil companies, and large retail businesses typically work this way.
Installment or closed-end credit calls for the borrower to settle the debt by paying a fixed amount regularly for a specific period of time. Car and personal loans are examples of installment credit.
Because credit costs vary, comparing costs can save the consumer money. The federal Truth in Lending Act requires creditors to provide information that will help consumers decide the best credit plan for them.
The main information provided by the Truth in Lending Act is a creditor's annual percentage rate, or APR. The APR is the annual rate that relates the total finance charge to the amount of credit received and the length of time to repay it.
In the case of installment credit, the creditor must provide specific information on the credit terms. These terms include the amount to be financed, the length of time to repay the loan, the monthly payment, the total finance charge, and the APR. Creditors offering different APRs or monthly payment amounts have different total costs for the same loan. Comparison shopping by the consumer will reveal the best credit arrangement for his or her particular situation.
Another consideration when selecting installment credit plans is the tax implications. Interest on consumer installment credit (except for mortgage interest) is no longer tax deductible. However, the interest on a home equity line of credit is deductible.
Credit is helpful in making purchases large and small. However, studying the different credit options available and their costs can help consumers keep finance charges to a minimum.