Consumer credit is money that consumers have borrowed from banks, financial institutions, or other businesses to make purchases. These organizations allow consumers to repay their outstanding balance over time in exchange for interest payments.
Access to various types of credit allows consumers to extend their purchasing power and take advantage of consumer-credit protections. Understanding how consumer credit works can help you manage your own credit wisely.
Definition and Examples of Consumer Credit
Consumer credit is money that consumers can borrow to pay for goods or services. Access to credit allows consumers to make purchases today and then pay for them over a period of time. Banks, financial institutions, and businesses make credit available to consumers.
Examples of consumer credit include:
- Credit cards
- Student loans
- Auto loans
Federal and state laws govern consumer credit to protect consumers from unfair lending practices and prevent businesses from discriminating against them based on non-financial factors.
Measuring the amount of outstanding consumer credit and periodic fluctuations helps economists gauge the health of the economy. Preliminary data as of March 2021 showed that American consumers had $4.2 trillion in outstanding consumer credit.
How Consumer Credit Works
Banks, credit card issuers, and some businesses extend credit to consumers through products like credit cards and loans. These credit products provide consumers the flexibility to pay for purchases over time, typically with monthly payments that are significantly smaller than the purchase price. In exchange, consumers pay interest to the lender.
The credit reporting system allows creditors and lenders to determine which consumers are the most ideal borrowers. Banks and credit card issuers keep track of consumer borrowing and repayment activity. They regularly share this information with credit reporting agencies, which compile all the credit information for consumers in a credit report. Credit reporting agencies then make consumer credit data available to future creditors so those creditors can determine a potential borrower's creditworthiness.
Having a history of repaying debts on time allows you to build a good credit history and, in turn, will allow you to borrow more money at better terms.
On the other hand, handling credit poorly makes it more difficult to borrow money, as lenders may not be willing to give you credit. Those that are willing to lend to consumers with poor credit history tend to charge higher interest rates and fees.
You have the right to view your credit information and dispute any errors with the credit bureaus or the businesses that provided the data.
Types of Consumer Credit
Installment Credit vs. Revolving Credit
Installment credit is a fixed amount of credit made available to you to use once, typically for a specific purchase, like a home or a vehicle. Repayment periods and monthly payments are usually fixed for the life of the loan, but your monthly payments could vary if your loan has a variable rate.
Revolving credit provides a set amount of credit that you can borrow from repeatedly as long as you stick to the terms. You'll have the flexibility of using your credit freely while making minimum payments toward your outstanding balance.
Both installment and revolving credit may charge interest on balances that you repay over time. Each may also come with additional fees.
Secured vs. Unsecured
Secured credit requires you to provide an asset or assets as collateral to get the loan. If you default on the credit agreement, the lender can take your collateral and sell it to pay your balance. Mortgages, auto loans, and secured credit cards are examples of secured credit.
By comparison, unsecured credit is not tied to assets that the lender can seize in the event of a default. Unsecured credit, like credit cards and student loans, tends to have higher interest rates because lenders consider them a higher risk since there’s no collateral.
How To Get Consumer Credit
To get consumer credit, you'll apply with a lender or credit card issuer. The application will ask you for personal information to verify who you are and determine whether you can repay what you borrow. In most cases, the lender will also check your credit history to see whether you meet their credit requirements and to determine the interest rate and repayment terms they offer you.
Certain types of consumer credit are easier to get than others. Credit cards, for example, are relatively easy to apply for and render quick approval, sometimes within seconds.
Mortgages, by comparison, require extensive documentation, an underwriting process, and can take more than a month to process. In general, the more money you borrow, the harder it may be to qualify for the loan.
- Consumer credit is money consumers borrow and repay over time.
- Banks, financial institutions, and businesses extend credit based on a consumer's borrowing history and ability to repay.
- Consumer credit can be secured or unsecured.
- Consumers can access credit products by applying with a lender or creditor.