What’s the difference between an open and closed line of credit?
To purchase a new vehicle or a home, or complete some home renovations, you’ll most likely need a loan. When you take out a loan, the type of credit may differ. Credit is borrowed money that a lender provides under specific repayment terms. Let’s explore the types of credit and how each can help you achieve financial goals.
Closed-end credit is a type of loan where the borrower receives a large lump sum upfront and agrees to pay back the full balance over a specific period of time, like a mortgage or auto loan. These loans cannot be changed once signed. Monthly payments include any interest and fees, and as you pay, you slowly build equity in the product. Once the loan is paid in full, the account is closed and the product is yours. Closed-end loans can be taken out only once and can be secured or unsecured.
- Secured loans require collateral, meaning borrowers agree to forfeit something valuable if they default on payments. For example, a mortgage loan’s collateral is the home itself as is the car for an auto loan. This protects lenders and in return, they can offer more competitive interest rates and fees.
- Unsecured loans do not require collateral. Without that insurance for the lender, rates and fees are largely influenced by the borrower’s credit score, which usually results in higher monthly payments.
Open-end credit is a pre-approved monetary limit to be used at your discretion. Credit cards and home equity lines of credit (HELOC) are just two examples. With open-end credit, you can continue using the same credit over and over as long as you make on-time payments.
- Credit cards offer a flexible credit limit, especially as your credit score improves. However, if your credit score decreases, some lenders will reduce your limit. You can choose to pay the minimum requirement or the balance in full at any time, but you must meet the minimum payment each month.
- A HELOC gives you the opportunity to use the equity you’ve built in your home to pay for home improvement projects, major purchases, or anything you might need “just in case.” After the set draw period, or the time in which you’re allowed to borrow funds, you only pay interest on the amount you use out of the total borrowed. Typically, this revolving credit line comes with an adjustable interest rate, which can be a risk if the rate increases greatly before you’ve repaid the balance.
Credit mix is an important factor in your credit score, so it’s vital to understand each type and how to use it to your advantage. If you have any questions, message our consumer lending team or call 816-245-4127 to get answers and make a plan to achieve your goals!