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Two Types of Credit: Closed- and Open-End

Consumer credit falls into two broad categories: closed-end (installments) and open-end (revolving.)

Closed-end credit. Closed-end credit is used for a specific purpose, for a specific amount, and for a specific period of time. Payments are usually of equal amounts. Mortgage loans and automobile loans are examples of closed-end credit. An agreement, or contract, lists the repayment terms, such as the number of payments, the payment amount, and how much the credit will cost. Generally, with closed-end credit, the seller retains some form of control over the ownership (title) to the goods until all payments have been completed. For example, a car company will have a "lien" on the car until the car loan is paid in full.

Open-end credit. With open-end, or revolving credit, loans are made on a continuous basis as you purchase items, and you are billed periodically to make at least partial payment. Using a credit card issued by a store, a bank card such as VISA or MasterCard, or overdraft protection are examples of open-end credit. There is a maximum amount of credit that you can use, called your line of credit. Unless you pay off the debt in full each month, you will often have to pay a high-rate of interest or other kinds of finance charges for the use of credit.

Also, debt can be secured or unsecured. Your loan is secured when you put up security or collateral to guarantee it. The lender can sell the collateral if you fail to repay. Car loans and home loans are the most common types of secured loans. An unsecured loan is made solely on your promise to repay. Nearly all purchases on credit cards fall into this catagory.

If the lender thinks you are a good risk, nothing but your signature is required. However, the lender may require a co-signer, who promises to repay if you don't. Since unsecured loans pose a bigger risk for lenders, they have higher interest rates and stricter conditions. If you do not repay an unsecured debt, the lender can sue and obtain a legal judgment against you. Depending upon your state's rules, the lender may then be able to force you to sell other assets to pay the judgment or, if you are employed by another, to garnish a portion of your wages.


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