Types of credit

Short-term Credit

When short-term credit is offered, the amount involved is usually small and the credit period extends to no more than 1 year.

Informal Credit

  • Credit is given without any written agreement.
  • Does not involve collateral security.
  • Small amounts are involved.
  • Repayment is to be made within one year.
  • Usually offered by the retailers to their trustworthy customers.

Credit Cards

Commercial Banks issue credit cards to their credit worthy customers. A credit card is a plastic card with a magnetic tape of a microchip on it. Credit cards let the card holder use credit up to a certain limit, which is determined by the bank after considering the credit worthiness of the customer.
Features of a credit card

  • Magnetic tape
  • Name of the card holder
  • Card Number
  • Expiry Date
  • CCV number on the back side

Advantages of credit cards

  • Convenient to use – Credit card can save time and is convenient compared to carrying cash with you. Credit cards are accepted all over the world, therefore it is very useful when travelling abroad. Minimized cash handling is also an advantage for the retailers as well.
  • Record keeping – Credit card statements can help you track your expenses. Some cards even provide year-end summaries.
  • Instant cash – Cash advances are quick and convenient, putting cash in your hand when you need it.
  • An interest free short-term loan – No interest charged if amount paid before the due date

Disadvantages of credit cards

  • It could tempt the card holder to spend beyond his means
  • Many shops and stores still do not accept credit cards
  • It is not available for everyone
  • Possibility of credit card fraud
  • Interest rates on cash advances are high, often compounded daily

Over draft

A short term facility offered by the bank to the its customers where the borrower can over draft (withdraw money more than their balance) their accounts maintained with the banks. This facility is available only for current accounts. It is used by businesses to manage cash flow problems.

Long-term Credit

  • The value of credit offered is high. It is usually for the purchase of durable goods or property.
  • Repayment period is more than 1 year.
  • A written agreement is signed, and usually a collateral security is involved.

Hire Purchase

A system by which a buyer pays for a thing in regular installments while enjoying the use of it.
During the repayment period, ownership (title) of the item does not pass to the buyer. Upon the full settlement of the payment, the ownership passes to the buyer. It is suitable for durable goods with a good resale value.

Lease back

An arrangement where the seller of an asset leases back the same asset from the purchaser. In a leaseback arrangement, the specifics of the arrangement are made immediately after the sale of the asset, with the amount of the payments and the time period specified. Essentially, the seller of the asset becomes the lessee(like the buyer of hire purchase agreement) and the purchaser becomes the lessor(seller) in this arrangement.

A leaseback arrangement is useful when companies need to un-tie the cash invested in an asset for other investments, but the asset is still needed in order to operate. Leaseback deals can also provide the seller with additional tax deductions. The lessor benefits in that they will receive stable payments for a specified period of time.

Extended Credit or Deferred payment

A deferred payment is an arrangement in which a debt does not have to be repaid until sometime in the future. The debt might be created when a person takes out a loan, for example, or purchases a good or service.
It is suitable for items with low resale value.
In this case customer will become owner after signing the agreement.
Customer can sell the asset any time.
Loans are secured by a collateral security.
If customer defaults making payment the financier has the right to sue the customer.

Store Cards

Store cards are plastic cards issued by departmental stores to the customers
Customers can buy goods and services up the given credit limit.
The amount used on the card has to be paid off at the end of the month.
Advantages of store cards
To the buyer
– Interest free purchase
– Extra services
To the seller
– Increased sales
– Customer loyalty

Disadvantages of store cards
To the buyer
– The customer tends to overspend as he/she does not have to pay
To the seller
– Bad debts

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