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Open End Credit and Closed End Credit

By: Amy Nickson

Obtaining mortgages, car loans, credit cards, or home equity credit lines are very common practices in today’s age. People take out loans to purchase items. Some people are successfully handling their credit while others are falling into debt due to improper usage or poor credit knowledge. Many people may still be unaware of the basics of consumer credit, the definitions of closed end credit and open end credit and their differences.

So let's discuss these items briefly in this article.

Closed end credit? Open end credit? Just what is credit?

The first thing to know is what credit is and how you use it. Credit is borrowed money that helps to purchase goods and services. You receive credit from a creditor or lender under agreed repayment terms. Understanding how credit works and how to deal with it properly can go far. Doing so can help to make you more effective at managing your credit. Your creditor/lender will consider you as a responsible borrower. Your credit score will rise with time. You may even be able to get a loan with favorable interest.

However, handling credit negatively does just the opposite. You will find difficulties in every aspect of life. Mainly, there are two types of credit - closed end credit and open end credit. However, knowing about the two types of credit is not enough. Understanding the differences will enhance your knowledge of how to handle each type of credit.

Closed end credit

Closed end credit is a type of loan which entails a fixed amount of funds, sometimes for a specific purpose. This loan must be paid including interest and financial charges within a stipulated period. For instance, if you take out a car loan or a real estate loan you'll be given a set amount of money with a particular repayment schedule. You have to repay the amount including interest and other financial charges on time each month. Once you pay off the loan, the account is closed.

Key points to know about closed end credit

  • You need to make regular, scheduled payments, which includes the principal and the interest rate until you pay off the borrowed amount in full.
  • Closed end credit is offered by financial institutions, often referred to it as an installment loan or a secured loan.
  • A written agreement should be made between lender and borrower. In the agreement, the total amount of loan, interest rate, the length of the repayment time, and the monthly payments should be mentioned.
  • The monthly payments will be based on the borrower's credit rating; the better your credit score, the lower the interest rate you may qualify for.
  • Obtaining closed end credit mainly requires a good credit rating. It is also one of the best ways to build a good score.
  • Closed end credit can help borrowers purchase expensive items like a house, a vehicle, furniture, and more.
  • With closed end credit, the interest rate and monthly payments will be fixed; these rates may vary from one lender to another.
  • Generally, the interest rates are favorable over open end credit.
  • Some lenders may ask for a down payment based on the borrower's credit rating.
  • The lender may charge penalty fees if the payments are not paid within the agreed time. Some lenders even charge a prepayment penalty fee if payments are made before the due date.

Open end credit

Open end credit allows you to make repeat purchases. You can pay the balance in full each month or make installment payments. With a credit card you have a certain amount of credit to use. You are obligated to repay the amount of credit that you have used. You can keep the credit line open forever, hence the term open end credit. Store or service credit cards and home equity credit lines are also considered to be open end credit.

Key points to know about open end credit

  • Open end credit is a pre-approved loan available from a financial institution.
  • Open end credit helps the borrower to control the amount they borrow.
  • You can make repeat purchases with an open end credit line. You don't have to make new credit agreements for using the accounts multiple times.

How do closed end and open end credit differ?

  • If you apply for an open end credit with a financial institution, you have multiple options, such as equity lines and credit cards. However, if you apply for closed end credit you'd be applying for a loan. The loan amount will be dispersed in full, unlike open end credit.
  • Open end credit allows you to put money in and take money out (as through a cash withdrawal or by making a charge). This type of credit has a limit that can't be exceeded without penalty charges. You need to pay interest only if there's a balance unpaid after the payment date of the same billing cycle. With closed end credit you cannot add to what you have borrowed. You must make payments on the loan until the interest and principal are paid off.
  • Open end loan can be borrowed multiple times. When you purchase an item, your available credit decreases. When you make payments you'll be able to reuse the same credit. But closed end credit is for a stipulated time with a specific interest rate and charges. It is ideal for making larger purchases. The term, loan amount, and interest rate will be decided by the lender.
  • Closed end credit cannot be altered once the agreement is signed. Both closed end and open end credit are perfectly designed for different requirements. Some consumers are comfortable with a flexible option like open end credit. On the other hand, some people like a structured loan for making a big ticket purchase.
  • Depending on your financial situation and need, both credit lines are important. Make sure you read the terms and conditions before making any agreements. Doing your research is the most important thing you can do for yourself.

Author bio:

Amy Nickson is a web enthusiast. She is associated with Oak view law group. She shares her expertise through her crisp and well-researched articles based on money management, money saving ideas and so on.