What Are the 4 Main Types of Credit?

Credit represents a fundamental aspect of personal finance, enabling individuals to acquire goods or services with a commitment to repay the borrowed amount at a future date. This arrangement typically involves a lender extending funds to a borrower, who then promises to return the principal, often with added interest or fees. Understanding the different forms of credit is important for effective financial management.

Revolving Credit

Revolving credit provides a borrower with continuous access to funds up to a predetermined maximum amount, known as a credit limit. The unique characteristic of this credit type is its ability to replenish as payments are made. This flexibility allows for repeated borrowing and repayment cycles.

Users of revolving credit are generally required to make a minimum monthly payment, and interest is typically charged on any outstanding balance carried over from one billing cycle to the next. Common examples include credit cards and personal lines of credit.

Installment Credit

Installment credit involves borrowing a fixed sum of money that is then repaid over a specified period through a series of consistent, scheduled payments. Each payment, or installment, typically includes both a portion of the principal loan amount and accrued interest. Once the total amount borrowed, plus interest, is fully repaid, the loan account closes.

Unlike revolving credit, the funds from an installment loan do not become available again after repayment. Examples of installment credit are widespread and include mortgages for home purchases, auto loans for vehicles, student loans for education expenses, and personal loans for various needs. These loans are characterized by their fixed principal amount, defined repayment term, and predictable monthly payments.

Open Credit

Open credit, sometimes referred to as open-ended charge accounts, is a form of credit where the full outstanding balance must be paid back at the conclusion of each billing cycle. Consequently, no interest charges are incurred on outstanding balances because they are not allowed to accumulate.

While there may not be a pre-set spending limit explicitly stated, internal limits can still apply based on a user’s payment history and credit behavior. Traditional charge cards, such as certain American Express cards, exemplify this model by requiring complete payment monthly. Utility bills, which are expected to be settled in full each period, also operate on a similar principle.

Secured Credit

Secured credit is characterized by the requirement of collateral, an asset pledged by the borrower to the lender as security for the loan. This collateral serves to reduce the financial risk for the lender. Should the borrower fail to meet their repayment obligations, the lender has the right to seize the pledged asset to recover the outstanding debt.

The presence of collateral often results in more favorable loan terms for the borrower, such as lower interest rates or more accessible approval, particularly for individuals with limited credit history. Common examples of secured credit include secured credit cards, where a cash deposit acts as collateral, auto loans where the vehicle itself is the security, and mortgages where the purchased home serves as collateral. It is important to note that “secured” describes a characteristic that can apply to both revolving credit, like a secured credit card, and installment credit, such as a mortgage or auto loan.