Closed End Credit - Explained
What is a Closed End Credit?
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What is a Closed-End Credit?
Closed-end credit is a kind of loan or credit that involves a complete disbursement of the agreed amount at the time of settlement, with the stipulation that the loan amount, interest and finance charges will be repaid within a specified date. Such credit can either involve the payment of the principal and interest in installments or as one single remittance at maturity.
How Does Closed-End Credit Work?
Closed-end credit is a type of loan or credit agreement signed between a lender and a borrower that includes details about the stipulated amount borrowed, interest rates and charges applicable, and monthly installments payable (depending on the borrowers credit rating). Procurement of a closed-end credit is a good indicator of the borrowers healthy credit rating. In most cases, closed-end credit revolves around a real estate or an auto loan, and is referred to as as an installment loan or a secured loan. Secured loans are usually disbursed by banks and other financial institutions. Contrarily, credit cards and home equity lines of credit (HELOCs) are open-end credits or revolving credits. Borrowers typically use closed-end credit to finance expensive assets such as property mortgages, furnishings and fixtures, electrical appliances, automobiles and boats. While open-end credit allows loan terms to be modified, the same is not true for closed-end credit. Also, unlike open-end credit, closed-end credit does not offer available credit. Closed-end credit mandates fixed interest rates (except mortgage loans that can have either fixed or variable rates) and monthly installment payments. These interest rates are decidedly lower than those offered by open-end credit. Moreover, both interest rates as well as payment terms show variances across firms and industries. It is obligatory for borrowers to apprise the lender of the purpose of the credit and also pay a down payment if required. For a borrower with a good credit score, the lender may choose to waive the requirement for a down payment. Closed-end credit also entails the enforcement of strict penalties for both prepayment (i.e. repayment of the loan before the due date) as well as payment delay and default. While penalty fees are usually the norm for delayed payments, it is not uncommon for lenders to repossess assets in case of defaults in loan payments by the borrowers. The longer the term of the credit, the more interest is payable by the borrower over time. Most closed-end credit involves home mortgages and automobile or boat loans. In such instances, the title of the asset remains with the lender until the loan is repaid in its entirety, following which the title transfers to the borrower. There are two loan types offered by closed-end credit:
- A secured loan, that make it obligatory for the borrower to pledge an asset as a collateral. Such loans have typically faster approval times.
- An unsecured loan, that is not protected by a collateral. Such loans have shorter loan terms.