How is open-end credit explained?
Broadly speaking, open-end credit is loan agreement between a lender or a financial institution and a borrower, which is also pre-approved. Here, the borrower can make repeated withdrawals, and repayments can be made before the due date. There is a limit attached to the open-end credit and can be repaid by the borrowers.
Revolving credit is also known as open-end credit.
Borrowers generally prefer open-end credit as they can exercise greater control over the money borrowed as well as on the repayment period. Here, the interest is imposed only on the amount borrowed rather than the full approved loan amount. Moreover, the borrower is not imposed with interest for the unused credit amount.
- Open-end credit is a form of credit where the lender extends credit facility to the borrower who can repeatedly use the funds to a certain specified limit.
- Revolving credit or a line of credit, are the commonly used terms for open-end credit
- Borrowers can make timely payments and again avail the fund amount.
- Lenders can revise the maximum credit limit depending upon the borrower’s credit score or loan repayment pattern.
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Frequently Asked Questions (FAQs):
Are there any examples of an open-end credit?
Some of the common examples of an open-end credit are home equity loans, credit cards, overdraft protection, department store credit cards, etc.
How does credit card act as an open-end credit?
Credit card is a very popular form of open-end credit. It provides easy accessibility of funds as and when required by the card holder. Its purchasing limit is fixed by the issuer depending upon the card holder’s credit rating as well as his credit score. When the holder makes the payment before the credit limit is exhausted, pre-approved funds are again made available to him.
How does open-end credit work?
In the event of open-end credit, both the lender as well as borrower enter into an agreement, where the former grants the latter the right to access and utilise the funds. Following which, the lender agrees to make timely repayments. The borrower may ask to raise the maximum amount, which can be done by the lender in cases where the former has a clean credit history and has made timely repayments.
On the other hand, a borrower’s credit limit is reduced if his credit score declines, or he defaults in making repayments. He can again avail the funds after making payment to the open-end credit account. It must be noted that funds can be accessed by the borrower if it does not go beyond the revolving credit line.
What are the advantages of open-end credit?
Merits of open-end credit or revolving line of credit are listed below:
One of the prime reasons why open-end credit is very popular among borrowers is that it is readily available. Usually, it is difficult as well as expensive for borrowers to seek funds after every two-three month and repay the full amount. However, with the open-end credit, borrowers can repeatedly avail funds after making timely repayment of funds being borrowed.
A lesser rate of interest
Moreover, since interest is charged only on the outstanding loan amount rather than the full unutilized amount, interest rates tend to be lower. This makes it very popular among small traders and borrowers as well as with individuals who have unpredictable sources of income.
Are there any demerits of open-end credit?
The demerits of open-end credit can be enumerated as follows:
Unpredicted changes in terms of credit
Sometimes, lenders change the credit terms without giving any intimation on the same. While timely repayment of funds often results in enhanced credit limits, default, or non-payment of the same may result in decreased credit limit as well as adversely affecting the credit score.
Increased interest rates
These open-end credits are unsecured credit funds with no collateral attached to them. Hence, they are usually equipped with high-interest charges. Moreover, borrowers are often asked to pay a monthly or annual fee for keeping the credit account running, thus adding an additional burden on the debtors.
Can the maximum credit limit in open-end credit be increased?
The maximum credit amount available in open-line credit is called a revolving credit amount. The limit can be amended depending upon the lender and the repaying capacity of the borrower.
As a reward for the timely repayment of the borrowed amount, the lender can increase the maximum credit limit, thus enabling the borrower to draw more funds as per his requirement.
However, the lender may reduce the said limit if the credit score of the borrower decreases or under conditions where a sporadic repayment pattern is seen on behalf of the borrower.
How open-end credit differs from closed-end credit?
Both open-end credit and closed-end credit are forms of credit; the two differ in terms of funds being disbursed and debt repayment. While in open-end credit, the full amount is granted at once, and the borrower may avail the fund amount depending on his requirement. With timely repayment of the loan amount, funds can again be drawn by the borrower.
However, it is not same with the closed-end credit. They are borrowed for a specific purpose and must be repaid after a specific duration, including the principal amount, interest charges as well as a maintenance fee, if any. One such example of closed-end credit is an auto loan.
While in open-end credit, borrowers can borrow funds a multiple number of times, where each borrow reduces the amount of funds. However, in case of closed-end funds, the borrower cannot add more funds to the initial borrowed fund amount.
Moreover, unlike the open-end funds where the lenders can increase or decrease the maximum available credit, the terms of closed-end credit cannot be modified once the agreement between both the parties (i.e., the loan giver as well as the loan taker) is signed.