How Closed-End Credit Is Paid Off
Credit is often used to refer to money you’ve borrowed or an amount of money you’re able to borrow from the bank or a credit card issuer. You’re able to use the credit for a variety of purposes as long as you stick to the payment terms. There are two basic types of credit: open-end credit and closed-end credit. It’s important to know what type of credit you have and is available to you.
Closed-End Credit vs. Open-End Credit
With open-end credit, you can keep using the same credit over and over as long as you make the minimum monthly payments on time each month.
Closed-end credit is a type of loan that you only take out once, such as an installment loan. After you repay your balance, you can’t use the credit or loan again. You’ll have to apply for new credit if you need to borrow again.
Most loans are a type of closed-end credit. You must repay the full amount of the loan plus interest and any fees within a specific amount of time. The time period for repaying closed-end credit is typically expressed in months.
How to Get Approved for Closed-End Credit
You can apply for closed-end credit from a bank or credit union. You may be able to use what you’ve borrowed for any purpose. Or, the lender may require that you use the credit for a specific kind of purpose. For example, an auto loan is a type of closed-end credit that must be used to purchase an auto. A personal loan, by comparison, is closed-end credit that you can use however you like.
To be approved for closed-end credit, the lender will check your credit history. They may require you to have a good credit score to be approved. In some cases, you may have to make a down payment. Your credit score will impact the amount you can borrow and the interest rate you pay.
Payment Terms on Closed-End Credit
Any time you borrow money, you’ll have to pay interest. With closed-end credit, the interest rate is typically fixed the entire time your loan is outstanding.
Occasionally, you might have closed-end credit with a variable interest rate. Closed-end credit usually has a lower interest rate then open-end credit, which makes it better for longer-term borrowing. You’ll pay less interest overall by taking advantage of a lower interest rate.
You’ll have a payment due every month until the balance is paid off. A portion of your payment will go toward the balance and the rest toward interest.
If you’re late on a payment, you’ll be charged a late fee. The credit bureaus may receive notice of your late payment if it’s more than 30 days late. You’ll be considered in default if your account becomes 90 to 180 days past due (depending on the terms). At that point, the lender will call the entire balance due and you won’t have the option to make monthly payments. This is also the case with open-end credit.
With open-end credit, you’re only required to make a small minimum payment toward your outstanding balance each month. On closed-end credit, you’ll have a fixed payment that allows you to pay off your balance with a set amount each month, which may make budgeting easier.
The monthly payments for closed-end credit are typically higher than the monthly payments for open-end credit, even for the same borrowed amount. Because you have a fixed payment schedule to stick to, you won’t have the flexibility to make lower monthly payments if you need to.
How Closed-End Credit Affects Your Credit
Your credit mix accounts for 10% of your FICO credit score. Having more types of credit is considered better than having only one type of credit. So, if you've already got credit cards (open-end credit) and add a personal loan (closed-end credit), that could help your score.
Otherwise, closed-end credit affects your credit the same way other credit accounts do. If the creditor reports your account to the credit bureaus, your timely payments will help boost your credit score. Late payments, on the other hand, can cause your credit score to drop.
While the account is in repayment, the creditor will send monthly updates on your account status to the credit bureaus. Once you’re done paying, the account will be closed and it will stay on your credit report for another 10 years or so. Any negative information associated with your account will fall off your credit report after seven years.
Secured vs. Unsecured Closed-End Credit Accounts
Closed-end credit can be secured or unsecured. Secured closed-end credit requires you to put up collateral that the lender can take possession of if you default on the loan terms. This may be required for larger loan amounts or when your credit doesn’t allow you to qualify for unsecured closed-end credit. Securing closed-end credit can improve your ability to get approved, increase the amount you can borrow, and lower your interest rate.
Unsecured closed-end credit, on the other hand, only requires you to meet the credit requirements and agree that you’ll repay the loan on time. You don't have to put up collateral that could be repossessed if you default, but the loan may be harder to qualify for.
The simplest way to tell whether you're applying for closed-end credit is to look at whether you can keep using the line of credit over and over again or you can only borrow once. If you borrow once then repay the funds, you're applying for closed-end credit. It certainly has its advantages. As with any borrowing situation, make sure you can comfortably afford the monthly payments before taking on a new debt obligation.