If you have a mortgage or a car loan, you have closed-end
credit. It's a type of loan with a fixed amount of funds
that you generally use for a specific purpose. You'll need
to pay the loan with interest in a particular repayment
schedule. Once you pay off the loan, your account will be
closed.
How Closed-End Credit Works
You and your lender agree to the amount you need to borrow,
the monthly payment, and the interest rate. These factors
are dependent on your credit rating. Getting closed-end
credit is an excellent way to
build your credit
by demonstrating to lenders that you can borrow responsibly.
You can use close-end credit if you're looking to make an
expensive purchase and pay for it over time.
Many lending institutions define closed-end credit as
secured loans
or
installment loans. Online lenders, credit unions, and banks offer a
closed-end lending option.
As mentioned before, auto loans and real estate are examples
of closed-end credit. Sometimes referred to as
revolving credit lines, credit cards and home equity lines of credit (HELOC) are
open-end credit. The main
difference between open-credit and closed-end credit
is the debt and how you repay it.
Closed-end credit is issued to you for a particular purpose
and must be paid within a set period. At the end of the
agreed term, you must pay the entire balance, including
interest and any maintenance fees. Closed-end credit does
not offer any available credit or revolve, and you cannot
modify the terms.
The monthly payments and interest rate are fixed. However,
the interest rates can vary between lenders. Closed-end
credit interest rates are generally lower than open-end
credit. The interest accrues every day on your outstanding
balance. Most closed-end credit loans have
fixed interest rates; a mortgage loan can offer a fixed or variable rate.
If you're looking to be approved for closed-end credit, you
need to inform the lender of the purpose of the loan. You
also may be asked to have a down payment.
Secured vs. Unsecured Closed-End Credit Accounts
Closed-end credit can be either unsecured or secured.
Unsecured closed-end credit does not require collateral if
you meet the lender's credit requirements and agree to repay
the loan on time with interest. Because no collateral is
needed, your credit score will need to be at least in good
standing for you to qualify.
On the other hand, secured closed-end credit requires you to
use collateral that the lender could possess if you default
on your loan terms. You may opt to use collateral because
you'd need a higher loan amount, or your credit score
doesn't allow you to be approved for unsecured closed-end
credit. Using secured closed-end credit can improve your
chances to be approved, lower your interest rate, and
increase your borrowing amount.
Common Examples of Closed-End Credit
Smartphone Financing
You can find smartphone financing at retail stores that sell
cellphones or through cellphone service providers. Most
providers allow you to pay off your devices in installments
with no interest or
finance charges. You'll most likely need a two-year contract to take
advantage of this benefit, and an upgrade fee also applies.
If you're not going to switch to another cellphone company
any time soon, then this option is for you. If you decide to
break your contract, you could be required to pay a fee - Or
pay off the balance that you owe.
In-Store Financing
Furniture stores and online retailers offer closed-end
credit.
You can walk into a store or apply online
by filling out a quick application. Once you're approved,
you'll have a fixed interest rate with weekly, monthly, or
bimonthly payments. You'll get your furniture delivered, and
you make payments until your furniture, computer, appliance,
or mattress is paid off with interest.
Car Loans
Using closed-end credit to make larger purchases is why you
would get a car loan. Auto lenders check if your income can
afford the monthly payments, your employment history if
you've had a previous car loan, your credit scores, and your
history.
Your interest rate will depend on your credit score, the
loan length, the size of your down payment, and the vehicle
you choose. If you have a loan and make your payments on
time and your credit score rises, you could refinance your
car loan to get smaller payments and get a better rate.
Education Loans
Paying for your education is another example of closed-end
credit. If you apply for financial aid, be sure to
understand where you get the loan from and the terms and
conditions. Student loans can come from banks, financial
institutions, or the federal government. Federal Student
Loans sometimes have better benefits than loans from private
sources and banks.
Mortgage
A mortgage loan is probably the most extensive closed-end
credit account you can acquire. You sign an agreement with a
mortgage lender to lend you the money to buy a home because
you don't have the cash upfront. This agreement gives your
lender legal rights to repossess your property if you fail
to meet the requirements and terms of your mortgage. The
process of failing to make payments and forfeiting your
property to your lender is called foreclosure.
Closed-End Credit Pros
Predictability
The positive side of closed-end credit is it offers
predictability and stability. With no annual fees and a
fixed interest rate and
term, you know how much your payment will be each month and can
budget accordingly. And when you've finished paying it off,
that debt is done with. These forms of credit are typically
more straightforward and with fewer fees.
Money All At Once
A closed-end loan gives the borrower the entire loan amount
upfront and requires them to pay it back over time in
installments.
Significant Purchases
Ideal for making a big-ticket purchase, you can get a car,
furniture, or a house using closed-end credit.
Lower Interest Rate
Closed-end credit usually has a lower interest rate than
open-end credit. However, interest is charged on the entire
principal
amount.
Closed-End Credit Cons
Not Flexible
Closed-end credit is not very flexible. You have to
determine how much funding you need before receiving it.
You'll need to refinance (at a cost) if you decide later
that you need more money. It's best to use this type of
credit if you make a large, single, predictable purchase. If
you have issues budgeting and making payment commitments -
This type of loan is not for you.
Maturity Date
Closed-end credit has a maturity date, at which time the
debt must be paid in full or refinanced. If you don't have
funds to pay at that time and don't qualify to refinance,
you're in trouble.
How to Get Approved for Closed-End Credit
You can apply online for closed-end credit from an
alternative lender, bank, cellphone provider, car
dealership, department store, or credit union. Generally,
you'll need to use the money you've borrowed for a specific
purpose. For instance, A
personal loan
is a type of closed-end credit you can use however you like.
A car loan, by comparison, is a closed-end credit that must
be used to purchase a vehicle.
Your lender will check your
credit history
before you're approved. If your credit score is on the lower
end, you may have to make a down payment. Your credit score
will impact the interest rate you pay and the amount you can
borrow.
Payment Terms on Closed-End Credit
Whenever you borrow money, you pay interest. The interest
rate is typically fixed on your entire closed-end credit
term. Although with certain mortgages, you could have a
variable interest rate.
Closed-end credit is a better long-term borrowing option
than open-end credit because it has a lower rate. You pay
less overall with a lower interest rate.
Conversely, your monthly payment for closed-end credit is
generally higher than open-end credit, even for the same
amount. Because you have a fixed payment to make every
month, you don't have the flexibility to make a lower
payment if you need.
If you make a late payment, your lender charges a late fee.
Your lender will report to the credit bureaus if your
payment is more than 30 days late. Depending on the terms,
you could be considered default if your account becomes 30
to 90 days past due. At that point, you lose the option to
make monthly payments because your lender will require the
entire balance you owe.
How Closed-End Credit Affects Your Credit
10% of your FICO credit score depends on your credit mix.
The more types of credit you have are considered much better
than having a kind of credit. If you already have a credit
card (open-end credit) and get approved for a personal loan
(closed-end credit), you will help your credit score.
Closed-end credit affects your credit score the same way as
other credit accounts. If your creditor reports your late
payments, your score will drop. On the flip side, your
on-time payments will help
boost your score.
While you pay your account, your creditor sends monthly
updates on your account status to the credit bureaus. Once
you finish paying, your account closes and stays on your
credit report for another ten years or more. Any unfavorable
information associated with your account will fall off your
credit report in seven years.
Is Closed-End Credit Right For You?
When you borrow any money, you need to consider that you can
afford new debt honestly. If you are still unsure if
closed-end credit is suitable for you, these points should
help you decide.
-
If you only need to borrow once and repay the funds over
time, a closed-end credit is right for you.
-
Your payments are based on your credit rating, and if your
credit is good, you may qualify for a lower interest rate
and save money over time.
-
If you want to build your credit, obtaining closed-end
credit will build your score if you make on-time payments.
-
Use closed-end credit if you need to purchase an expensive
item like a vehicle, house, furniture, and more.