When we hear the term credit, we often associate it with the borrowing of a loan.
What is credit?
Credit refers to the process of borrowing money or other goods and services and repaying the lender later. The providers of this service, also known as creditors, grant a certain amount of funds or services knowing that their credit will be repaid with the stipulated interest. The use of credit is seen in a multitude of fields such as personal loans in the UK, credit for the purchase of houses or vehicles, agricultural loans, loans for business or services required for a company.
If you have good credit, you are said to be credit-worthy, and lenders are more likely to sanction credits and services in your name. This procedure of borrowing and lending is based wholly on trust, defying which, could lead to hefty penalties. You can read all things about applying for a credit card in the UK from Creditspring blog.
As we discuss the topic of ‘what is credit’, there is another term we ought to consider called line of credit. Line of credit (LOC) is the facility provided by banks to individuals, businesses or the government that helps the customer borrow in different forms including the overdraft limit, loan, export packing credit in the UK, and so forth.
It is a convenient source of funds for customers that can be discreetly availed, and the interest is paid only on the money withdrawn. LOC can either be secured or unsecured. The funds received by the customer won’t be affected. The concept of ‘what is credit’, along with LOC is essential for every individual or organization to understand to make a well-informed decision while applying for a fund borrowing.
Mechanisms of Credit
Back in the day, your chances of acquiring credit or being a credit-worthy candidate for a loan application were solely dependent on your reputation. However, the modern approach in the UK has adopted a more systematic procedure. One of the most important things to keep in mind to understand what credit is is the concept of credit history.
Credit history refers to a record of all your past loans or credits borrowed and when the repayment has been made. Lenders tend to keep a close eye on defaulters and late payers, often penalizing them by rejecting their application.
When we talk about ‘what is credit’, it is essential to consider that a low credit score, owing to late payments, missed payments, multiple rejections, hard searches and so forth, creates a negative impression on the lender and your application is less likely to be approved. Your credit history is reported by banks in the UK, credit card issuers and other creditors. It provides information like the number of credit cards you own, number and amount of loans taken, whether monthly payments were made on time or missed entirely and if there were any significant financial setbacks at the time of borrowing.
A fundamental understanding of what is credit helps us reach the conclusion that credit is receiving something of value from a creditor or lender, and promising to pay it later at a stipulated interest associated with the borrowed amount.
The three most vital things related to credit are credit cards, credit scores and loans, and credits. The three are bound by their functionalities concerning credit. Cards are used to spend the credit by exchanging it for goods; scores reflect your credit-worth and loans are actual funds that you borrow from the bank in the form of money, often borrowed for the purchase of products.
Keep in mind while understanding the concept of ‘what is credit’ that there are multiple lines of credit that customers in the UK can choose from depending on the degree and type of need.
Lines of Credit
Now that we know what credit is, we can move onto the different lines of credit available in the UK. LOC is a means by which a customer can borrow funds with flexibility and as per requirement until the allowed limit has been reached. When the credit limit is reached, and all the money is repaid, money may be borrowed again if there is an open line of credit. A LOC is associated with the maximum amount of credit that the customer can borrow. This agreement is mutual between the financial institution i.e. the bank and the borrower. The fund can be accessed by the borrower at any time from the LOC, keeping in mind that the credit limit cannot be exceeded and payments are made in a timely fashion.
Unsecured and Secured LOC
Maximum LOCs are unsecured loans. With this LOC, the borrower does not pledge collateral to the bank or the lender to back the LOC, except in the case of home equity line of credit, which is secured by the home of the borrower.
Customers usually prefer a secured line of credit as they can make provisions for funds in the case of non-payment. A secured LOC also ensures higher maximum credit limit paired with a low-interest rate when compared to an unsecured LOC. The catch with an unsecured LOC is that the customer needs to have a credit score well above 700 as lenders take a considerable risk.
Revolving and Non-Revolving LOC
An open-end credit account, also known as a revolving account, allows the customer to borrow money, spend it, repay and borrow again virtually over and over again in a revolving cycle. Revolving accounts are famously characterized by credit cards. Closed-end credit accounts have a procedure in which customers borrow a certain amount of money and then pay it back in equal installments monthly. Once the payment has been returned, the borrower cannot use up any more funds until another loan has been approved.
Establishing the answer to the question – what is credit is crucial when you get to borrowing and lending actively. Credit cards, history of payments, i.e. the credit records and loans are critical aspects of credit. As we get into ‘what is credit,’ the concept of Line of Credit ought to be taken into account. LOC helps customers borrow flexibly, spend the loan and repay. Different types of LOCs are available, and individuals, businesses and the government can take their pick that is best suited to their needs.