What is a Credit Instrument?

Credit instruments are items that are utilized in the place of currency. Just about all individuals and businesses make use of some type of credit instrument on a daily basis. The ability to use such an instrument instead of currency rests in the fact that debtor and the recipient agree upon the use of the instrument and there is a reasonable expectation that the alternate form of payment will be honored.

One of the earliest forms of a credit instrument is the check. Utilized by consumers as a legitimate means of paying for goods and services received, the value of the check is underwritten by funds that are placed in a bank account. Upon the presentation of the check by the recipient, the bank deducts the specified amount as recorded on the check by the debtor. While the check is no longer the main credit instruments employed in many financial transactions, it remains in use by many businesses and individuals.

The credit card is another example of a common credit instrument. Using a credit card to pay for a purchase creates a contract between the buyer and the seller. Essentially, the seller is extending credit to the buyer with the assumption that the company issuing the card will cover the amount of the purchase. In turn, the issuer of the credit card is anticipating that the cardholder will eventually pay off the amount of the debt along with applicable interest and finance charges.

A third type of credit instrument is the promissory note. With this arrangement, debtors receive funds from lenders with the understanding that the note will be repaid in full at a future point in time. This type of debtor’s obligation may carry a specific date for repayment of be open-ended. Promissory notes may be utilized in the lending of funds between individuals or between two business entities.

There are two main advantages to the use of a credit instrument. First, the consumer does not have to carry a great deal of currency in order to make purchases. Second, the instrument can usually be replaced with relative ease when damage, loss, or theft of the instrument takes place. This is in contrast to cash, which usually cannot be replaced when damaged, stolen, or lost.