What Is Consumer Credit?
Consumer credit is personal debt taken on to purchase goods and services. A credit card is one form of consumer credit.
Although any type of personal loan could be labeled consumer credit, the term is more often used to describe unsecured debt that is taken on to buy everyday goods and services. However, consumer debt can also include collateralized consumer loans like mortgage and car loans.
Consumer credit is also known as consumer debt.
- Installment credit is used for a specific purpose and is issued for a set period of time.
- Revolving credit is an open-ended loan that may be used for any purchase.
- The disadvantage of revolving credit is the cost to those who fail to pay off their entire balances every month and continue to accrue additional interest charges.
- The average American had a credit card balance of $5,315 in 2020, according to Experian.
Understanding Consumer Credit
Consumer credit is extended by banks, retailers, and others to enable consumers to purchase goods immediately and pay off the cost over time with interest. It is broadly divided into two classifications: installment credit and revolving credit.
Installment credit is used for a specific purpose and is issued at a defined amount for a set period of time. Payments are usually made monthly in equal installments. Installment credit is used for big-ticket purchases such as major appliances, cars, and furniture. Installment credit usually offers lower interest rates than revolving credit as an incentive to the consumer. The item purchased serves as collateral in case the consumer defaults.
The average American had a credit card balance of $5,315 in 2020, according to Experian.
Revolving credit, which includes credit cards, may be used for any purchase. The credit is "revolving" in the sense that the line of credit remains open and can be used up to the maximum limit repeatedly, as long as the borrower keeps paying a minimum monthly payment on time.
It may, in fact, never be paid off in full as the consumer pays the minimum and allows the remaining debt to accumulate interest from month to month. Revolving credit is available at a relatively high interest rate because it is not secured by collateral.
Consumer credit use reflects the portion of a family or individual's spending that goes to goods and services that depreciate quickly. It includes necessities such as food and discretionary purchases such as cosmetics or dry cleaning services.
Consumer credit use from month to month is closely measured by economists because it is considered an indicator of economic growth or contraction. If consumers overall are willing to borrow and confident they can repay their debts on time, the economy gets a boost. If consumers cut back on their spending, they are indicating concerns about their own financial stability in the near future. The economy will contract.
Advantages of Consumer Credit
Consumer credit allows consumers to get an advance on income to buy products and services. In an emergency, such as a car breakdown, that can be a lifesaver. Because credit cards are relatively safe to carry, America is increasingly becoming a cashless society in which people routinely rely on credit for purchases large and small.
Revolving consumer credit is a highly lucrative industry. Banks and financial institutions, department stores, and many other businesses offer consumer credit.
Disadvantages of Consumer Credit
The main disadvantage of using revolving consumer credit is the cost to consumers who fail to pay off their entire balances every month and continue to accrue additional interest charges from month to month. The average annual percentage rate on all credit cards was 14.75% at the end of Q1 2021 according to the Federal Reserve. A single late payment can boost the cardholder's interest rate even higher.