Consumer Credit is the capacity of a consumer to get a loan or credit. Consumer credit is a short and intermediate term loan used to refinance debt incurred or to finance the acquisition of goods or services for personal consumption. Consumers most frequently use credit cards, issued by financial institutions, as credit instruments. Such credit cards are a form of consumer credit.
Consumer credit could also refer to any sort of personal loan, although it is more frequently used to denote unsecured debt that is incurred to pay for regular products and services. Consumer debt can, however, also refer to secured loans like mortgages and auto loans.
Banks, shops, and other businesses give people credit so they can buy things right away and pay for them over time with interest. Lenders may provide the loans in the form of cash loans, or sellers may provide the loans in the form of sales credits. It has become a major force in many developed and developing economies. The American economy is heavily dependent on consumer credit i.e. individuals use credit as a basic tool for personal and financial planning.
5 Cs of Consumer Credit
Not all have the privilege of consumer credit. It is not accessible to all individuals and businesses. Lenders have some criteria forproviding credit. For instance, Banks do not provide credit cards to all the clients, they measure the creditworthiness of the borrower. Different lenders have different parameters to measure the creditworthiness. Some of such parameters are:
- Character of borrower: It is the reputation of the borrower and the repayment history. It includes all the past credit schedules of the borrowers.
- Capacity of the borrower: This means the ability of borrowers to pay back its obligation. For this, lenders consider the revenue stream, cash flow, repayment schedule, expenses headings etc. It is basically the income of the lender against its debt.
- Capital with the borrower: It is the amount or investment with the borrower beforehand the consumer credit. This means, no one gets 100% in credit, borrowers need to show some investment in any form to get the credit. For instance, banks provide credit cards based on your transaction details. Similarly, businesses provide credit based on your cash flow and payment regularities. Loan companies provide different loan terms based on the down payment amount.
- Collateral for credit: Collateral is the security for the credit. It is the guarantee in case of any credit defaults. Lenders recover the credit amount by settling it with collateral.
- Condition of the borrower: This includes the status of the borrower while applying for the credit. The revenue stream, any form of employment, any past credit history, market conditions etc. reflects the conditions.
Benefits of Consumer Credit
Consumer credit is one the important concept in modern economy. There are multiple benefits to credit economy. Some of the benefits of consumer credits are:
Credit history building
Consumer credit can be a useful instrument for developing the credibility of consumers.Such credit analyzes credibility by measuring the strong payment history for consumer credit accounts. Banks and other financial institutions are more likely to provide the loans if the consumers have solid credit history and pay interest on time.
Increasing Credit Rating
Credit score can be favorably impacted by a track record of on-time payment of interest on credit cards, loans, and other forms of consumer credit. A consumer can increase their credit ratings by paying the interest and loan amount on time. It makes them trustable and credible in the eyes of the creditors. It is also for due diligence.
Benefits and Rewards
Credit for consumers, especially credit cards, can give out goods like airline miles, hotel points, and cash back rewards to the consumers. Such fringe benefits make consumers feel premium and this maintain consumer loyalty. Different consumer credit types/strategies build the association with the companies.
Protection against frauds
Consumers are safeguarded against fraud with credit cards, which also offer features like contactless cards, card-locking options, virtual card numbers and minimal to no cardholder liability for unlawful purchases. Also, there exists different protection acts and laws for consumer credit.
Repaying certain purchases
Some credit card companies will compensate consumers for certain transactions if they’re unhappy with a product they bought but the seller won’t accept a return. So, having a this credit will benefit the consumers by purchasing certain products if the consumers are not satisfied with the products.
Disadvantages of Consumer Credit
While there are advantages of consumer credit, there are also some disadvantages of it which are as follows:
- Costs associated with consumer credit can include interest rates and possible fees which are costly and sometimes hectic for the consumers.
- Consumers might be able to spend beyond their means if they have access to consumer credit. This encourages extravagant spending.
- Not being able to pay interest and high debt levels may harm consumers’ credit and limit their future access to loans. Ratings and Score doesn’t explain the cause behind the irregularities in interest payment.
- If consumers accumulate a lot of consumer debt, their debt may be transferred to a debt collector, who may pester consumers nonstop about paying the amount. This can be annoying at times.
- Consumers could be forced by some predatory lenders to take out loans at exorbitant interest rates.
Category of Consumer Credit
There are two categories of consumer credit.
- Installment Vs Revolving Credit
- Secured Vs Unsecured loan.
A predetermined amount of credit that is made available to consumers for a single purchase, usually a home or a car, is known as an installment credit. While monthly payments and repayment schedules are typically set for the duration of the loan, if your loan has a variable rate, the monthly payments may change. In most cases, payments are given in equal monthly increments. Large purchases like furniture, vehicles, houses and major appliances are made using installment credit. As an inducement to the consumer, installment credit frequently has lower interest rates than revolving credit. In the event that the consumer defaults, the object purchased acts as collateral.
The most prevalent form of consumer credit is revolving credit. Credit cards are the most well-known and widely utilized example of this. Consumers, nowadays, uses credit cards to pay for common goods and services at the point of sale. As long as the consumer follows the rules, revolving credit offers a fixed amount of credit that they can use repeatedly.
Credit cards that are subject to revolving credit are accepted for all types of purchases. As long as the borrower makes the minimum monthly payment on time, and may be utilized repeatedly up to the free limit. Due to the lack of collateral, revolving credit is offered at a rather high interest rate.
Secured loan refers to the loan amount in which certain assets are kept as collateral by the borrower against the loan taken. To obtain a loan with secured credit, consumers must put up an asset or assets as collateral. The lender may take collateral and sell it to cover debt if consumers don’t pay as agreed upon in the loan arrangement. Secured credit includes things like mortgages, auto loans, and secured credit cards.
Unsecured loan indicates the loan amount in which the borrower doesn’t keep any collateral for the loan taken. Such credit, in contrast, is not backed by property that the lender could seize in the event of a default. Since there is no collateral involved, lenders tend to view unsecured credit as a higher risk.
Credit cards, Student loans, Mortgages, Auto loans, etc. are the examples of consumer credit. A loan taken out to pay for the purchase of an automobile is an example of consumer credit. Auto loans are frequently installment loans, meaning that they must be repaid over time in set installments. No matter the nature of the loan, the loan will still have interest costs.