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Consumer credit provides access to more spending power, which enables you to do things like take out a home loan or make purchases with a credit card. Responsible use of consumer credit can open doors to new opportunities, but borrowing also has the potential to result in unmanageable levels of debt. As of June 2021, U.S. consumers had more than $4.3 trillion in outstanding consumer credit, according to the Federal Reserve. Read along to learn more about the power and potential perils of consumer credit.
What Are the Main Types of Consumer Credit?
There are two broad ways consumer credit is categorized: how it's paid back (revolving vs. installment), and whether it requires collateral (secured vs. unsecured). The credit types you use—whether it's personal loans, credit cards or mortgages—fit into these categories. It's likely that you've got both installment and revolving credit as well as secured and unsecured credit.
Revolving and Installment Credit
Installment credit typically refers to loans, such as mortgages, auto loans, personal loans and student loans. With installment credit, you repay what you borrow in fixed payments made each month over a set period of time, or term. The monthly payments, or installments, are based on the amount you borrow plus the interest you owe.
With revolving credit, you can borrow money numerous times a month as long as you stay below your credit limit. You'll have to make at least a minimum monthly payment on revolving credit on or before the account's due date. The amount of your monthly payment will depend on how much money you've borrowed and whether you regularly pay off the full balance to avoid interest changes. If you don't pay off your debt immediately, it rolls over—or "revolves"—to the next billing period.
Secured and Unsecured Credit
Secured debt is backed by collateral—such as a home, car or cash deposit—that a lender can take to cover your debt if you fail to pay back the loan. Types of secured credit include mortgages, auto loans and secured credit cards.
Unsecured debt does not involve collateral. Credit cards, personal loans and student loans are often unsecured, and are lent primarily on the basis of someone's creditworthiness. When a lender extends unsecured credit, it typically charges a higher interest rate than it would for secured credit. That's because a lender assumes more risk with unsecured credit than secured credit.
Lending Sources for Consumer Credit
Consumer credit is available from a variety of lending sources, such as:
- Credit unions
- Online lenders
- Peer-to-peer lending platforms, such as LendingClub and Prosper
- Consumer finance companies, whose products include personal loans
- Sales finance companies, whose products include auto loans and furniture loans
- State and federal agencies (student loans)
- Payday lenders
- Pawn shops
- Family and friends
Advantages of Consumer Credit
Consumer credit could offer a number of advantages, depending on how you use it. They include:
- Building your credit history: If you establish a solid payment history for consumer credit accounts, including credit cards and personal loans, and otherwise handle credit responsibly, consumer credit can be a valuable tool for building your credit.
- Boosting your credit score: A positive history of making payments on credit cards, loans and other types of consumer credit can positively affect your credit score.
- Providing perks and rewards: Consumer credit, particularly credit cards, can deliver goodies like airline miles, hotel points and cash back rewards.
- Protecting you against fraud: Credit cards provide all sorts of ways to protect yourself against fraud, such as contactless cards, virtual card numbers, card-locking capabilities and little to no cardholder liability for unauthorized purchases.
- Reimbursing certain purchases: Some credit card issuers reimburse you for purchases if you're not satisfied with an item you bought but the merchant won't accept a return.
Disadvantages of Consumer Credit
While consumer credit provides advantages, it also provides disadvantages. Some of those are:
- Consumer credit can come at a cost, including interest charges and potential fees.
- Access to consumer credit might enable you to spend beyond your means.
- Missed payments and high debt levels could damage your credit and impact your ability to obtain credit in the future.
- Piling up a lot of consumer debt could result in your debt being turned over to a debt collector, who might constantly nag you about paying the debt.
- Some predatory lenders might trap you into borrowing money at sky-high interest rates.
The Bottom Line
Consumer credit comes with trade-offs: You balance the freedom and convenience of borrowing money with the costs and potential pitfalls of debt. For instance, a mortgage gives you the freedom to buy a home, but falling behind on mortgage payments could harm your credit history and might even lead to the loss of the home. If you're careful with consumer credit, however, the freedom and convenience can far outweigh the risks.