Open-End Credit: Definition, How It Works, vs. Closed-End Credit

What Is Open-End Credit?

Open-end credit is a loan from a bank or other financial institution that the borrower can draw on repeatedly, up to a certain pre-approved amount, and that has no fixed end date for full repayment. Open-end credit is also referred to as revolving credit. Credit cards are one common example.

Key Takeaways

  • Open-end credit is a type of loan that the borrower can draw money from repeatedly up to a certain pre-approved limit.
  • Unlike closed-end credit, it has no fixed end date for repayment.
  • When the borrower repays some of the money they have borrowed, it restores that portion of their pre-approved limit.
  • Credit cards and lines of credit are examples of open-end credit and are also referred to as revolving credit.
  • Open-end credit is different from closed-end credit, in which the borrower receives money in a lump sum and must pay it back by a fixed end date.
  • Mortgages and car loans are examples of closed-end credit.

How Open-End Credit Works

Open-end credit is credit that you can withdraw from and repay repeatedly for an indefinite amount of time. Types of open-end credit include a line of credit or a credit card, which are also considered revolving credit.

With open-end credit, when you repay what you owe, the amount of credit you have available increases again.

Here are some examples of open-end credit:

Credit Cards

With a credit card, for example, the card issuer will set a credit limit based on such factors as the card holder's income and credit score. If, for example, the limit is set at $20,000, the cardholder can spend up to that much. If they spend $5,000 in a month, they would then have $15,000 left to spend on that card.

Once the cardholder has paid back the $5,000, their credit limit will be back at $20,000. Each month they will also be charged interest on their outstanding balance and have to make at least a minimum monthly payment. This cycle can continue for as long as the credit card holder keeps that card.

Personal Lines of Credit

Lines of credit come in a variety of forms. Personal lines of credit serve much the same purpose as credit cards. In most cases, the borrower can take out money whenever they wish, up to the pre-established limit.

Most personal lines of credit are unsecured, meaning that they aren't backed by any collateral from the borrower, but based instead on the lender's assessment of the borrower's creditworthiness.

Home Equity Lines of Credit (HELOCs)

Home equity lines of credit (HELOCs) are an example of secured lines of credit. The lender will open a line of credit based on the amount of equity that the homeowner has in their home. The home serves as collateral.

Like other lines of credit, HELOCs can be useful if the borrower needs access to money but not all at once. For example, someone might take out a $50,000 HELOC to finance a remodeling project that they plan to do, and pay for, in stages.

A home equity loan, by contrast, is an example of a closed-end loan. The borrower receives a lump sum of money (such as the $50,000 in the example above) all at once. They must then repay it in installments until it is fully paid off by a certain end date. Closed-end loans are sometimes referred to as installment loans, with mortgages, car loans, and student loans being common examples.

Advantages and Disadvantages of Open-End Credit

Like any type of credit, open-end credit has both pros and cons to consider.

A major advantage of open-end credit is that the borrower has to pay interest only on the amount they use. For example, someone with a $50,000 home equity line of credit who has borrowed $10,000 from it so far will only owe interest on that $10,000, not the other $40,000. If, on the other hand, they had taken out a home equity loan for $50,000, they would start owing interest on the full amount from day one.

Another advantage is that open-end credit can be used for just about any purpose. Credit cards are the most obvious example, but this is true for lines of credit as well. Closed-end credit, by contrast, is may issued on the condition that it be used for a specific purpose, such as to buy a house or a car.

Flexibility is an advantage, but it also has risks as well. Revolving loans may even encourage overspending. That could be a particular danger for someone with multiple credit cards, each with its own credit limit.

In addition, credit cards and other forms of open-end credit often have variable rather than fixed interest rates that can increase.

Does Open-End Credit Help Your Credit Score?

Open-end credit can either help or hurt your credit score, depending on how you use it. If you have a credit card, for example, and reliably make at least the minimum required payment each month, that can help your credit score. However, if you max out your card, or get too close to its credit limit, that will affect your credit utilization ratio, which can lower your score.

What Is a Credit Utilization Ratio?

Your credit utilization ratio is a measure of the amount of debt you have outstanding at any given time compared to the amount of credit you have available to you. For example, if you have a credit card with a $20,000 credit limit and owe $10,000 on it, your credit utilization ratio on that card is 50%.

What Is a Good Credit Utilization Ratio?

Credit scores, and prospective lenders, typically favor credit utilization ratios of 30% or less, and the lower, the better.

The Bottom Line

Open-end loans are useful in a variety of situations and offer flexibility that closed-end loans do not. At the same time, some borrowers can get into an unmanageable amount of debt with them. To stay out of trouble it's a good idea to keep an eye on your credit limit and try not to get too close to it.

Article Sources
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  1. Federal Reserve. "Revolving Credit."

  2. Consumer Financial Protection Bureau. "Credit Cards."

  3. Experian. "What Is a Credit Utilization Rate?"

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