Two basic types of credit
There are two basic types of credit: open-ended and closed-ended loans.
Open-ended loans are made on a continuous basis for the purchase of products up to a specified limit. Bills are issued monthly for a portion of the loan. Credit cards are examples of open-ended credit.
Once you have your credit card, open-ended credit makes it easy to make purchases and have them added to your bill. This can be convenient, but you may also be less aware of the finance charges accrued than if you used an installment loan. Generally, the finance charge for credit cards is figured at 1.5 percent per month (or about 18 percent annual percentage rate). You could pay more or less depending on the type of credit card you use and its issuing bank.
The balance on which the finance charge is computed may also vary. It is the least costly for you if the interest rate is applied to the balance after recent credits and payments have been subtracted. The most common method is for the interest to be applied to the average daily balance. Some retailers figure finance charges on the previous balance before subtracting any payments or credits; this is the least advantageous to you. Regardless of the method used, the creditor must tell you how your finance charge is computed.
Periodic statements (bills) for charge accounts require you to make a minimum payment on the balance due. Unlike installment loans, open-ended accounts give you some flexibility in repaying what you owe. It's to your advantage to pay as much as possible each month to avoid finance charges. During difficult financial times, you have the option of paying the minimum on your charge account until the next billing period. If you continually pay only the minimum, however, you may eventually pay more in finance charges than the cost of the item you purchased.
Closed-ended credit involves a one-time loan made for the purchase of a costly item like an automobile or major appliance. The payment period, number of payments and payment amounts are specified. Installment loans are closed-ended.
Interest rates on closed-ended credit accounts can vary widely, so check with several lenders before borrowing. Closed-ended credit lets you know exactly how long you will be indebted and how much you are paying in finance charges. This kind of regular payment is easier to budget for. Should other bills come due in one particular month, however, closed-ended credit does not allow for any flexibility in payment amounts.
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