Modules for Beginners
All about credit cards
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Credit today: Different credit options
We’ve come quite a long way from the time when credit was first ever used for a transaction. What probably started off as “I’ll pay you back later” has now undergone several evolutionary cycles. We currently have so many different credit options to choose from that we are actually spoilt for choice! That’s not all. Thanks to the advent of technology, getting a credit facility has also never been this easy. Getting back to the original point, let’s go ahead and take a look at the different credit options that we currently have with us.
Types of credit options
When it comes to credit, there are primarily two different types - open credit or revolving credit and closed credit or installment credit. Here’s a more in depth look at the types of credit options.
Open credit or revolving credit
This is one of the most, if not the most, popular credit options. One of the widely used credit options is revolving credit as it involves borrowing again and again up to a specific limit and then repaying over a period of time. The limit is called the credit limit, which is the maximum amount you are allowed to spend on that specific account. Revolving credit is used because it comes as a support for anyone with financial emergencies and allows them to manage their available finances in a better manner.
There’s a very good chance that you already own this type of credit option. It usually comes in the form of a small plastic card that you can fit in your wallet. Yes, we’re talking about the credit card. Wondering why the credit card is categorized as open or revolving credit? Here’s some information that can help clear things out.
Now, a credit card comes with something called a credit limit. You’re free to borrow as much as you need till you hit this limit. And at the end of the month, you’re required to repay whatever you’ve borrowed. If you either don’t repay at all or only repay a portion of your total borrowings, you incur heavy penalties and interest charges. That said, if you do repay in full at the end of the month, your credit limit gets replenished completely.
The fact that you can borrow freely and the fact that the credit limit gets replenished each time you repay in full are two of the reasons why a credit card is categorized as open credit or revolving credit. Some of the other open credit options other than credit cards are listed below.
- Bank overdraft
- Charge cards
- Travel and entertainment cards
- Debit cards
Surprised to see debit cards under the open credit option? Here’s a quick look at the reason why they fall under this category. Debit card is a credit facility that a bank offers you. However, instead of repaying the borrowed amount at a later date, you do it almost instantaneously from your account. Although it is not ‘credit’ in the technical sense, it is treated as such.
Closed credit or installment credit
This is among the types of credit options where you can borrow a fixed amount and repay the same over a preset number of monthly installments. Again, this type of a credit option is also something that you might have already encountered in your daily life. If you’ve ever taken a loan for whatever reason, you probably already know what we’re going to see next. Yes, a loan is a classic example of closed credit or installment credit. Why, you ask? Here’s why.
Let’s say you take out a car loan of Rs. 10 lakhs at an interest rate of 10% for 5 years. You would have to repay the loan in monthly installments, which includes both the principal and the interest components, over the tenure of 5 years, right? This comes out to around Rs. 20,038 each month for 5 years, which is a total of 60 months.
Now, once you take out this loan, you cannot freely borrow anymore in addition to the Rs. 10 lakhs that you’ve already availed. If you need more credit, you would have to apply for a new loan. That’s not all. With closed credit options, you can only avail the loan in its entirety and not on an as-needed basis.
Also, in this type of a credit option, your credit doesn’t get replenished as and when you repay the loan. For instance, let’s say that around 2 years after you take out the loan, you’ve managed to repay close to Rs. 5 lakhs. In a closed credit option, although you’ve freed up Rs. 5 lakhs, you can’t borrow the Rs. 5 lakhs again, unlike a credit card.
These are a few of the reasons why loans are categorized as closed credit or installment credit. Some of the other closed credit options are -
- Personal loans
- Education loans
- Home loans
- Automobile loans
- Consumer durable loans
Service credit or non-instalment credit
This is one of the types of credit wherein a borrower is permitted to pay a specific service such as membership at a club, water, electricity etc. This is also among the types of credit wherein payment may vary from one billing cycle to the next based on the usage.
Well, that’s about it with the different types of credit options. Now that you’ve been introduced to them, we’re going to be directing our focus towards trying to understand more about credit cards in the forthcoming chapters of this module. Till then, stay tuned.
A quick recap
- When it comes to credit, there are primarily two different types - open credit or revolving credit and closed credit or installment credit.
- Revolving credit involves borrowing again and again for a specific limit and then repaying over a period of time. The limit is called the credit limit, which is the maximum amount you are allowed to spend on that specific account.
- Closed credit is among the types of credit options where you can borrow a fixed amount and repay the same over a preset number of monthly installments.
Service credit is one of the types of credit wherein a borrower is permitted to pay a specific service such as membership at a club, water, electricity etc.
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