Use of credit

Concept of credit

consumer credit is defined as credit granted to an individual especially to finance the purchase of consumer goods or to defray personal expenses.

The idea behind the use of credit is either to enable a person enjoy consumer goods now and pay later or to use money that he is yet to earn.

The originator of credit is the person or company who originally extended the credit, while the holder is the individual or business who obtained the debt at a discounted price in order to collect payments at a subsequent time. Auto dealers are credit originators at the time a consumer purchases an auto on credit, but many loans are subsequently assigned by them to banks or sales finance companies, which become credit holders.

Increased use of credit

As the standard of living in a country goes up, the consumers are tempted to purchase more and more goods, many of which are expensive durable goods. We can see that more and more people are involved in buying goods on credit in various methods. The type of goods that are often bought on credit schemes are motor vehicles. Leasing companies have also seen that their services are more and more used by the people. This allows people to buy goods which they would never be able to buy without such credit schemes.

Therefore, we can see that the use of credit by people and the willingness of business to offer goods on credit terms have increased. As a result of this, sales has also increased, which in turn has also increased bad debts.

Advantages of credit to the buyer

  • As mentioned above, use of credit enabled many people to buy goods which would otherwise be impossible for them to buy
  • It thus increases standard of living of the buyer
  • Payments can be made in installments
  • It is convenient. Carrying big amounts of cash is risky, it is rather preferable to first pay using a credit card and then make the payment later

Disadvantages of credit to the buyer

  • Even though not always the case, sellers often charge interest when they offer goods for credit. Therefore, the buyer ultimately pays a higher price
  • Credit schemes often tempt people to buy goods which are not necessary
  • Failure to make the payment may result in loss which is even bigger than the original credit. For example, mortgaged property may be sold(often at a discounted price) by a lending bank to recover a loan.
  • Future income is used at present, which effects future spending power

Advantages of credit to the seller

  • It increases the sales, since many will buy from the seller who gives credit.
  • He could get loyalty of the customers by giving them credit in times of necessity
  • If payments are successfully collected, it becomes more profitable to sell on credit since no discount is given, and actually an interest is also often charged when giving credit

Disdvantages of credit to the seller

  • Money is sometimes not recovered from the buyer (bad debts)
  • Late payment – the money is stuck with the debtors and thus it is a big opportunity cost
  • Cash flow problem – several shops in small communities have gone bankrupt because of cash flow problems which was the result of giving credit.

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