What is Consumer Credit?
Consumer credit is credit extended to individuals for the purpose of allowing them to use goods and services while paying them off. Regional definitions for this concept vary. In some regions, any type of loan made for a personal finance activity, including things like mortgages, is considered consumer credit. In other areas, credit for purchases that are considered investments is not classified as consumer credit, and thus mortgages and margin accounts for investments are not forms of consumer credit.
In the broadest sense, consumer credit includes credit cards, store charge cards, personal loans, vehicle loans, and other lines of credit. The credit may be for a specific item, as when people apply for car financing, or it may be an open line of credit as with a credit card that can be used to buy anything. Financial institutions that originate consumer credit determine how much credit should be offered and on what terms.
Consumers pay for their credit. Origination fees are common with loans, and people also pay interest, as they are repaying the funds they have spent. Issuers of credit use these costs to make a profit on their loans. Interest and origination fees can vary, depending on the customer and the issuer. For certain types of credit, people may be required to take out insurance to protect their ability to repay. For car loans, for example, lenders usually require that borrowers carry comprehensive insurance on their vehicles to repay the loan in the event that the car is totaled.
Availability of consumer credit fluctuates, depending on economic pressures. When the economy is good, credit is often readily available and consumers can potentially find themselves deep in consumer debt if they take advantage of all the credit available to them. In periods of economic downturn, credit markets tend to tighten because financial institutions are more risk-averse, and it can be more challenging to obtain credit for personal purchases.
Several tools can be used to evaluate how much credit a person or household can safely carry. Financial institutions use credit reports and other information to decide how much credit to offer. People taking on debts may want to consider how much the cost of servicing those debts will add to their monthly expenses. It is also advisable to think ahead of time and consider what will happen in the event of job loss or other life events that might interfere with the ability to repay debts.
@Logicfest -- Some have argued that making credit too available leads to artificial price inflation. The theory goes that if people are more worried about a monthly payment instead of how much something actually costs, businesses have an incentive to raise prices.
That theory sounds pretty solid, but is there actually a relationship between the availability of credit and inflation? I suspect that notion is hotly debated by economists as there are so many schools of economic thought that disagreements are common.
Believe it or not, there was once a time when economists believed that rising consumer debt levels were a good thing. Increased consumer debt does increase spending in the short term, but the simple fact is that it has to be paid back one day. When enough people get in over their heads and cut back on spending so they can service their debts, or go bankrupt, a recession is inevitable.
There's nothing wrong with consumer credit, of course, but making it too easily available can have a negative impact on the economy in the long run.
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