What Is Closed-End Credit?
Closed-end credit is a loan or type of credit where the funds are dispersed in full when the loan closes and must be paid back, including interest and finance charges, by a specific date. The loan may require regular principal and interest payments, or it may require the full payment of principal at maturity.
Many financial institutions also refer to closed-end credit as "installment loans" or "secured loans." Financial institutions, banks, and credit unions offer closed-end credit agreements.
- Closed-end credit is a loan or type of credit where the funds are dispersed in full when the loan closes and must be paid back, including interest and finance charges, by a specific date.
- Many financial institutions also refer to closed-end credit as "installment loans" or "secured loans."
- Closed-end credit agreements allow borrowers to buy expensive items–such as a house, a car, a boat, furniture, or appliances–and then pay for those items in the future.
How Closed-End Credit Works
Closed-end credit is an agreement between a lender and a borrower (or business). The lender and borrower agree to the amount borrowed, the loan amount, the interest rate, and the monthly payment; all of these factors are dependent on the borrower's credit rating. For a borrower, obtaining closed-end credit is an effective way to establish a good credit rating by demonstrating that the borrower is creditworthy.
Generally, real estate and auto loans are closed-end credit. Conversely, home equity lines of credit (HELOC) and credit cards are examples of open-end credit. Open-end credit agreements are also sometimes referred to as revolving credit accounts. The difference between these two types of credit is mainly in the terms of the debt and how the debt is repaid. With closed-end credit, debt instruments are acquired for a particular purpose and for a set period of time. At the end of a set period, the individual or business must pay the entirety of the loan, including any interest payments or maintenance fees.
Open-end credit arrangements are not restricted to a specific use or duration, and there is no set date when the consumer must repay all of the borrowed sums. Instead, these debt instruments set a maximum amount that can be borrowed and require monthly payments based on the size of the outstanding balance.
Closed-end credit agreements allow borrowers to buy expensive items and then pay for those items in the future. Closed-end credit agreements may be used to finance a house, a car, a boat, furniture, or appliances.
Unlike open-end credit, closed-end credit does not revolve or offer available credit. Also, the loan terms cannot be modified.
With closed-end credit, both the interest rate and monthly payments are fixed. However, the interest rates and terms vary by company and industry. In general, interest rates for closed-end credit are lower than for open-end credit. Interest accrues daily on the outstanding balance. Although most closed-end credit loans offer fixed interest rates, a mortgage loan can offer either a fixed or a variable interest rate.
Borrowers who wish to be approved for a closed-end loan or other types of credit arrangement must inform the lender of the purpose of the loan. In some instances, the lender may require a down payment.
Secured Closed-End Credit vs. Unsecured Closed-End Credit
Closed-end credit arrangements may be secured and unsecured loans. Closed-end secured loans are loans backed by collateral—usually an asset like a home or a car—that can be used as payment to the lender if you don't pay back the loan. Secured loans offer faster approval. However, loan terms for unsecured loans are generally shorter than secured loans.
Some lenders may charge a prepayment penalty if a loan is paid before its actual due date. The lender may also assess penalty fees if there are no payments by the specified due date. If the borrower defaults on the loan payments, the lender can repossess the property. A default can occur when a borrower is unable to make timely payments, misses payments, or avoids or stops making payments.
For certain loans, such as auto, mortgage, or boat loans, the lender retains the title until the loan is paid in full. After the loan is paid, the lender transfers the title to the owner. A title is a document that proves the owner of a property item, such as a car, a house, or a boat.