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.
Breaking Down Closed-End Credit
Closed-end credit is an agreement between a lender and borrower or business. The lender and borrower agree to the amount borrowed, the loan amount, the interest rate, and the monthly payment, which depend on the borrower's credit rating. Obtaining closed-end credit is an effective way to establish a good credit rating and demonstrates that the borrower is creditworthy.
Generally, real estate and auto loans are closed-end credit, but home-equity lines of credit and credit cards are revolving lines of credit or open-end. Many financial institutions refer to closed-end credit as an installment loan or a secured loan. Financial institutions, banks, and credit unions offer closed-end credit.
Closed-end credit allows borrowers to buy expensive items and pay for the items in the future, such as a mortgage, auto, 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.
The interest rate and monthly payments are fixed. However, the interest rates and terms vary by company and industry. The interest rates are lower than open-end credit interest rates. 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 must inform the lender of the purpose of the loan. In some instances, the lender may require a down payment. For example, a lender approves a customer with a credit score of 700 for an auto loan for 48 months with a monthly payment of $300 at a 4% interest rate with zero down payment.
Some lenders may charge a prepayment penalty if a loan is paid before the due date. The lender assesses penalty fees if the specified due date does not make payments. If the borrower defaults on the loan payments, the lender can repossess the property.
A longer loan term means that the borrower pays more in interest charges over time. For certain loans, such as an 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.
Secured vs. Unsecured
Closed-end credit offers secured and unsecured loans. Closed-end secured loans offer faster approval and require collateral to secure or protect the loan from default. Loan terms for unsecured loans are generally shorter than secured loans.