What is Credit

Published on 21 July 2012 by Raffick Marday

Different types of credit

Confused about different types of credit?

What is credit?

You are granted credit when an organisation or individual makes a sum if money available for you to borrow.There are two main types of credit.

  • Revolving credit on payment cards can give you access to a fixed amount of money that you can spend as you wish, in a wide range of retailers and other outlets
  • Home loans, or mortgages, and personal or shop loans are linked to a specific item or items – for example, a new kitchen, or a house

Repayment

Revolving credit means that you always have access to the amount of your line of credit that remains unspent. And every time you pay off some of the outstanding amount, that proportion of your credit limit becomes available for you to spend again.

So if you have a credit limit of £1,000, spend £300 and repay £100, you have £800 available to spend.

Loans are normally repaid in regular installments over an agreed period of time. Mortgages, or home loans, can be repaid in variable installments but most personal loans specify fixed repayments of approximately equal amounts.

If you want to make another major purchase when you have finished paying off one loan, you need to negotiate a new loan.

Whatever type of loan you choose, be certain to make your repayments on time, or you can face financial penalties.

Interest

In order to cover the lending risk and to make a profit on their money, lenders generally charge interest on loans and revolving credit. You must remember this when you are calculating your repayments.For example, if you borrow £100 and interest is payable at an annual rate of ten per cent, the total cost is £110. This is known as simple interest. It is rarely charged on borrowings.

Compound interest is more common. It means that interest is charged on the interest at regular intervals.

For example – if you owe £100 and are charged ten per cent compound interest each year, at the end of year one you will owe £110. In year two, the lender will charge ten per cent of this sum and add it to the outstanding amount, so you will owe £121, and so on. Interest may be compounded after any period – a day, a week, a month and so on.

With fixed repayment loans, the amount of interest is worked out in advance and added into the repayments. There is often a penalty if you want to repay the outstanding amount earlier than agreed.

With revolving credit, you can repay as much or as little as you want, at any point. You can often avoid paying any interest at all if you repay the total amount you have borrowed on the date when the first repayment is due.

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