Closed-End Credit: Definition And How It Works
Miranda Crace4-minute read
UPDATED: August 17, 2023
When you’ve paid off a credit card’s balance, you can then leave that account open to use again or close it. However, some types of loans and consumer credit – known as “closed-end credit” – will automatically close an account once you’ve repaid it in full.
But, what are all the major differences between closed-end credit and other types of credit debt? Let’s take a look at how closed-end credit works and consider some specific examples.
What Is A Closed-End Loan?
Closed-end loans or credit, commonly called “installment loans,” are typically taken out for a particular purchase or expense the borrower needs to finance. Lenders agree to loan out a specific amount, which the borrower has to then pay back in smaller increments – plus interest – over the course of a repayment period.
A lot of closed-end credit is secured by a form of collateral, but you’ll find exceptions like personal loans and student loans that are typically unsecured.
Closed-End Credit Examples
Financial institutions like banks, credit unions and private lenders usually offer different forms of closed-end credit. Examples include:
- Mortgage loans
- Car or auto loans
- Home equity loans
- Student loans
- Personal loans
How Does Closed-End Credit Work?
As mentioned above, you repay a closed-end loan over a series of predetermined monthly payments – the number of which depends on your loan amount, interest rate and the length of your loan term. The loan is distributed in a lump sum to the borrower.
When you apply for a loan, your lender or creditor reviews your financial situation and creditworthiness to determine if you qualify and what your annual percentage rate (APR) will be if you do qualify. Your APR encompasses your interest rate, finance charges and any other fees associated with your loan. Your credit score will play a big role in you qualifying for and getting a good interest rate.
Interest rates for closed-end credit can be fixed or variable. A fixed rate remains the same until the loan is paid in full, and a variable rate can go up or down depending on the economy and market conditions.
Your loan is due to be fully repaid by a certain date, and falling behind on payments or missing them entirely could make you default on the loan – resulting in any number of consequences depending on your type of loan. Defaulting on a mortgage, for example, could mean you lose your home to your lender or creditor.
Closed-End Vs. Open-End Loan
Open-end credit, or “revolving credit,” doesn’t typically have a set time when the account closes. Borrowers can withdraw up to a certain amount of money from a line of credit and make the minimum required payment or pay more toward the balance every month.
Common examples of open-end credit include credit cards, personal lines of credit and home equity lines of credit (HELOCs). Some examples of open-end credit, such as a HELOC, have a fixed draw and repayment period at the end of which you can renew the credit line or close the account.
The funds typically aren’t restrictive and can be used for any purchase or expense as long as you stay within your credit limit. Your monthly payment will differ depending on how much you withdraw, and you only pay interest on what you borrow.
How Closed-End Loans Can Affect Your Credit Score
Closed-end credit can affect your credit score in various ways, some of which are in your control.
Making on-time monthly payments toward your closed-end loan will give your credit score a boost over time, while late or missed payments will bring your score down. Delinquent accounts can remain on your credit report for up to 7 years.
Having a variety of open- and closed-end credit can also give your score a healthy credit mix, further improving your credit score and showing future lenders you can manage different types of debt.
Keep in mind, though, that a closed-end credit account closes once the loan is fully repaid, and a closed account may cause a dip in your credit score. If the account was positively affecting your credit score, its closing will cause your score to lower slightly.
Closed-End Credit FAQs
Have more questions about closed-end credit? See if yours are answered below.
What is closed-end credit used for?
Closed-end credit is usually restricted to a specific purchase or expense. For example, a mortgage loan can only be used to buy a house. Likewise, an auto loan is strictly for a vehicle, and student loans are only good for higher education purposes. The exceptions to this rule are personal and home equity loans, both of which can finance a variety of purchases.
What is closed-end credit also known as?
As explained above, closed-end credit is more commonly referred to as an installment loan, named so for the monthly “installments” paid throughout the loan’s term. An installment or closed-end loan is any debt repaid over multiple payments.
What is a disadvantage of closed-end credit?
Some notable cons of using closed-end credit include the potential for high interest rates, which are determined largely by the strength of your credit score. Closed-end credit can also come with additional fees and finance charges. Personal loans, for example, may require borrowers to pay origination fees.
Closed-end credit allows borrowers to finance a large purchase and repay it through monthly installments, making many major purchases more attainable. A borrower can also give their credit score a welcome boost by keeping up with their monthly payments and diversifying their credit mix. Remember, though, that your credit score at the time you apply could determine your interest rate until you’ve paid back the loan in full.
If you feel like your credit score could use a boost, take steps to improve it today.
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