WHAT IS CREDIT ?
Credit is money granted by a creditor
or lender to a debtor or borrower, who defers
payment of the debt. In exchange for the credit,
the lender gets back the money, usually paid
on a monthly basis, plus interest. The debtor
gets the use of the money to pay for and take
possession of things today and the creditor
gets back more money that s/he loaned out.
Modern society is dependent upon credit to
generate sales; it enables people to have
the things they want and need, but can’t afford
to pay for right away.
Interest is the compensation that is demanded
by the creditor for the use of his/her money.
Money has a “time value” to it; over time
(due to inflation) the value of money decreased:
what a pound will buy today is much less than
what a pound could purchase 20 years ago.
Since a creditor pays out money today in exchange
for a repayment of it in the future, the creditor
loses the time value of that money. In order
that creditors make credit available, they
are allowed to charge interest, often referred
to as a finance charge. For example, if a
lender gives you £10 worth of credit, s/he
might expect to be repaid £11 within the next
two months; the extra pound is the interest
charged for the loan. Click here for a Free
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Interest on credit can be either simple or
compound.
Simple interest is interest charged only on
the principal amount borrowed. Simple interest
does not add the interest charge back to the
outstanding loan during the length of the
loan. Thus, simple interest charges are less
than compound interest charges. Compound interest
is interest charged not only on the principal,
but on the interest accrued during the length
of the loan. Compound interest is more expensive
to the debtor, because interest is charged
on interest.
The amount of interest that can be charged
is sometimes regulated by law.
Credit is extended pursuant to a written contract.
The written contract sets forth the respective
rights and responsibilities of the creditor
and the debtor. Credit can be used by both
businesses and individuals. When an individual
uses credit, it is referred to as “consumer
credit”. |
