Millions of people in the United States of America have credit. It is the biggest way that people pay for purchases of every kind. Credit can be given in different ways and for different things. So, today, we have a look at the different types of credit that you can get. We also look at the things that banks and other credit providers look at before giving credit to an applicant.
Types of Credit
There are four main types of credit. Each type has different options that fall into it.
1. Secured Credit
Secured credit is a type of credit where the lender has to put up an asset or amount of money as a guarantee against your credit. A lien gives the creditor the right to take the money or asset if the borrower does not stick to the agreement and pay back their credit. In this way, the creditor ensures that he gets his money back if the borrower fails to bring his side.
The types of credit that fall under secured credit include mortgages, home equity loans, and car loans.
2. Unsecured Credit
Unsecured credit is a type of credit where you don’t need to put up any assets or money as a lien. The creditor basically takes your word that you will pay back what you use. This is credit with a lot of freedom and should be used responsibly.
The types of credit that fall into this category include credit cards, store credit, medical, and utility bills.
3. Revolving Credit
Revolving credit is a type of credit where the creditor gives you a credit limit. You are approved for a set amount based on income and other factors. You can use this credit whenever you want and however you want. You are required to pay a minimum instalment monthly on the outstanding balance to keep your revolving credit. So, as long as you don’t reach the limit of the credit, you will have money to spend.
The types of credit that fall under revolving credit include credit cards with a credit limit and home equity lines of credit.
4. Instalment Credit
Instalment credit involves set parameters. You borrow a specific amount of money from the creditor for a set time period. You repay the money through set instalments over a certain period of time. The terms will be set out in a contract. In other words, you know ahead of time how much you are borrowing and how much and long you will be paying that money back.
The types of credit in this category include car loans, student loans, and mortgages.
What Do You Need to Qualify for Credit?
Creditors or lenders must take steps to ensure that they will not lose money if they approve you for credit. There are certain things that they look for to determine whether a person will be a good candidate for credit or not. Based on specific criteria, they evaluate a person’s eligibility to be approved for credit.
The criteria they use are often called the 5 Cs of Credit.
When they evaluate character they look at your consumer behavior and your credit history. They evaluate whether you will repay your debt as agreed. They look at how you have paid your bills (or not) in the past. So, basically, they look at your spending behavior and how well you have settled debt in the past.
The lender also needs to look at what they can use as collateral. It is their way of ensuring that they don’t lose all their money. Collateral would be assets like a house or car. Sometimes, lenders require a security deposit of a certain amount to use as collateral. When they evaluate this aspect they look at what you have in your name that could be used as a safety net for them.
Capacity refers to your actual monetary value. They look at your income and investments. They evaluate the money that comes into your account and often also how much your expenditure is on a monthly basis. This will give them an idea of whether you will be able to pay back the credit. They look at your actual financial ability to meet repay requirements.
Capital refers to your net worth. This links with capacity. When they look at capital they compare your assets and income and expenditure. Based on that, they can calculate whether you will have enough money left on a monthly basis to make repayments or pay instalments.
This last part of their evaluation does not apply to you. In this stage, they look at the financial conditions in the economy, the country, and the bank. The economy fluctuates and interest rates do too. The lender has to look at how much money is available to lend without taking too big a risk. When money is scarce in the country, interest rates go up. This means that you will pay back a lot more than you receive.
Being approved for credit is often not just a case of walking in and getting a credit card or a loan. There are certain conditions and safety precautions that must be taken on both sides. Taking on credit is a big responsibility and you should do so wisely. Before you apply, you can evaluate yourself based on the 5 Cs and find out what the lender will see. If you don’t think the picture is good enough, try and improve your habits and debt situation before applying for credit.