What's Closed-End Credit?
Let's talk credit! Credit is money you borrow and should repay. With respect to the type of credit account it's, technology-not only for various purposes, like purchasing a boat, funding a marriage or buying an investment property.
There are two main types of credit open to borrowers – closed-end credit and open-end credit. Obviously, you need to know which type you're trying to get. We'll touch on both here but mainly focus on closed-end credit.
Closed-End Credit vs. Open-End Credit
Let's have a quick look in the differences between closed-end credit and open-end credit:
- Closed-end credit: This is an installment loan borrowers usually remove for any specific purpose. Lenders extend a specific amount of money that must definitely be repaid (including interest) over a set time period. Mortgages, car loans or student loans are types of closed-end credit.
- Open-end credit: This is revolving credit (aka line of credit). Lenders extend a line of credit having a fixed borrowing limit to borrowers. Borrowers can repeatedly take advantage of the line of credit during the withdrawal period. The funds can be used as pretty much any purchase or investment so long as you don't exceed your borrowing limit. You pay interest on which you withdraw or use for purchases. Credit cards, home equity lines of credit (HELOCs) or personal credit lines are types of open-end credit.
How Closed-End Credit Works
Closed-end credit is really a one-time installment loan you typically take out for a specific purpose. You are making monthly obligations which include the loan's principal balance and interest throughout the repayment period. If you need more income after the loan pays off, you will need to obtain a new loan.
Secured vs. Unsecured credit
Whether it's closed-end or open-end credit, there are times when you may want to secure the loan to be approved with a lender or creditor. When you secure credit, you are able to typically borrow more money or get better loan terms. It may also help you be eligible for a a loan or credit line if you have poor credit.
- Secured credit: To get secured credit, you must provide the lender collateral (like your house or personal belongings) they are able to repossess in case you default around the loan. Secured personal loans can be simpler to qualify for than short term loans and frequently have lower rates of interest and better credit line amounts. Before you're approved, the lender must figure out how much the collateral may be worth, which might increase your wait for a funds.
- Unsecured credit: Because unsecured credit doesn't require collateral, you can usually get the money faster since the lender won't spend any time determining the need for any collateral. But you usually can't borrow just as much money as you could with a secured loan because there is no collateral to secure your debt. These financing options can be harder to get than secured personal loans and typically have higher interest rates.
Will Closed-End Credit Affect Your Credit Scores?
Closed-end credit affects your credit like every credit account would – how you manage your financial troubles could affect your credit scores. If your lender reports your account towards the credit agencies, they'll send monthly updates of your payment activity.
Your payment history makes up a sizable portion of your credit score. Late payments on your closed-end credit accounts can decrease your credit ratings; on-time payments can improve your scores.
Once the loan is paid off, the account is closed. The closed account will show on your credit history for approximately 7 years if there were any derogatory remarks (just like a delinquency) or as much as 10 years if it was closed up to date.[1]
Your credit utilization ratio, which is how much money your debt compared to how much you can borrow, is another large number of your credit rating. But it's calculated according to your open-end credit accounts (credit cards or lines of credit), not your closed-end credit accounts (mortgages, car loans, student education loans, etc.).
Bonus tip: Credit mix makes up a small percentage of the credit ratings, so having various kinds of credit accounts can slightly impact your scores. If you're able to responsibly manage your debt, a mixture of open-end credit accounts and closed-end credit accounts might help boost your scores a bit.
How Do You Get Closed-End Credit?
You can apply for closed-end credit from a bank, a credit union (a high level member) or an online lender. Depending on the type of loan you are looking for, there may be lenders that specialize in those loans, like mortgages or student loans.
Lenders will look at the credit history to help determine your creditworthiness (a sign of how much lenders can depend on you to definitely repay financing). Depending on the loan and also the lender, borrowers might need to meet different requirements to qualify. Usually, the primary requirements you will need to meet are:
- Minimum credit score
- Proof of revenue and residence
- Debt-to-income (DTI) ratio
In certain cases, you may need to create a down payment on your loan, and lots of fees could come with it. A lender could also ask you to provide additional information like bank statements, assets, proof of insurance or titles.
Borrow Once, Then Repay
If you're unsure which kind of credit you're trying to get, consider if you are able to only take a loan once or if you can repeatedly borrow from a credit line. With closed-end credit, you take a loan once and repay the loan. With open-end credit, you continuously borrow out of your credit account and repay as you go.
As with any kind of credit, be sure you find affordable to repay that which you borrow before you apply.