Consumer Credit: Defined And Explained

Existing consumer debt in the U.S. is at an all-time high, up to $14.9 trillion in 2020 from $800 billion back in 2019. It’s no wonder, as the pandemic that ravaged much of the world has left consumers scrambling to figure out how to pay their bills.

Consumer credit can be useful in many parts of your financial life. To help you understand what it is and how to use it responsibly, we take a deeper look in this article. 

What Is Consumer Credit?

Consumer credit, also known as consumer debt, is issued to qualifying consumers to purchase everyday goods and services, such as groceries, travel expenses, and furniture. It is not used to purchase assets, such as a home, stocks, bonds, or anything that increases in value over time. Student loans are also not considered consumer credit, as that is a form of debt to help you with long-term goals like your career.

Consumer credit is given out by banks and retailers so that consumers can purchase goods and services and pay it back over time. Creditors charge interest for the privilege of using consumer credit — interest rates reflect the borrower’s creditworthiness. In other words, the lower the credit score, the higher the interest rate.

The two types of consumer credit are revolving credit and installment credit.

Revolving Credit

The most popular kind of revolving credit is a consumer credit card. These cards can be used for purchases up to the allowed credit limit. It’s called revolving credit because the line of credit is open indefinitely and can be used as many times as the consumer wishes, as long as they meet the minimum payment requirements.

In other words, as long as the credit card user makes on-time payments and for a minimum amount stipulated by the credit card issuer, the consumer can keep using it. What this means is that the credit card user doesn’t have to have the entire credit card balance paid off in full to keep using the credit card. However, they will have to pay interest on the remaining balance from month to month.

Since revolving credit usually isn’t secured by some form of collateral (like a car or a home), the interest rate is higher. This reflects the risk the credit card issuer is taking on by allowing you to access credit.

Installment Credit

Installment credit, unlike revolving credit, lends out a specific amount of money for a defined period of time. The funds tend to be used for a specific reason and paid back in equal amounts. For instance, loans for large purchases such as a home, vehicle and major appliances usually are installment credit loans.

These types of loans offer lower interest rates compared to revolving credit, since they’re secured loans. The item a consumer purchases serves as the collateral in case the loan goes into default. Compare this to unsecured loans, where the consumer doesn’t have to put down any collateral to secure a loan.

What Is A Consumer Credit Report?

A consumer credit report is a document that contains details about your credit and loan activity. Information you’ll find includes specifics about current loans, how much you owe, payment history and credit account statuses.

There are three major credit bureaus — Experian®, EquifaxTM, and TransUnion® — that collect and store financial information about you. The information is also used to determine your credit score, a three-digit number representing your creditworthiness. Lenders, credit card companies and other financial companies can request access to your credit report when deciding whether to loan you money and determining what interest rates to offer.

The higher your credit score, the less risky a borrower you appear to be because you exhibit signs that you’re more likely to make on-time payments. Knowing your credit score is important because it will help you understand the types of loans you may qualify for and whether you’ll receive competitive rates. If it’s low, understanding your score will help you to determine the types of actions you need to take to boost your credit.

Taking On Consumer Debt: What To Consider

If you need to take on consumer debt, you’ll want to consider the pros and cons of your decision before filling out an application.

Pros

• Build credit: Opening a new loan or credit card allows you to build your credit score if yours is low, or you’re just starting out. In this case, consider opening a credit card, putting small purchases on it and making sure you pay it off on time.
• Access funds: Emergencies happen, like your car breaking down or finding yourself short on money to make a much-needed home repair. Having access to consumer credit in this case is helpful so you can pay for these necessities, especially if you don’t have an emergency fund.
• Help with long-term goals: Some loans can help with goals that aren’t only about purchasing items. For instance, taking out student loans helps you to earn a degree or certificate that you can use to help you land a job or promotion.

Cons

• High fees: Interest rates on loans can get really expensive, especially if they’re in the double digits like many credit cards. Taking advantage of debt consolidation may help, but you may have to pay fees to access a new loan at a lower interest rate.
• You can stretch yourself thin financially: If you’re not careful or responsible with credit, you can easily buy more things than you can truly afford. This can lead to higher monthly debt payments, potentially ones that will negatively impact your budget and credit score down the line.
• It costs money to borrow money: Purchases on credit will cost you more than the sticker price of the item since you’ll be paying interest on it.

The Bottom Line

Consumer credit can be useful, as long as you’re responsible with it by making on-time payments and making sure you can afford it. It can help you in emergencies, finance large purchases, and even help to advance your career. Credit cards in particular can be useful if you’re someone who is interested in earning cash or travel rewards.

To see what you may qualify for, check your credit report to gain useful insight into what it takes to borrow at the most competitive rates.