Depending on the need, an individual or business may take out a line of credit that is either open-ended or closed-ended. The difference between these two types of credit is mainly in the terms of the debt and the debt repayment. Learn more about how each type of line of credit works.
Key Takeaways
- A line of credit allows you to withdraw the amount you need when you need it instead of receiving a lump sum.
- Closed-end lines of credit have an end date for repayment.
- Open-end lines of credit usually have no end date for repayment, or a very long term for revolving credit.
- A closed-end line of credit is commonly used in homebuilding, when an end date for construction is established.
Closed-End Credit
Closed-end credit includes debt instruments that are acquired for a particular purpose and a set amount of time. At the end of a set period, the individual or business must pay the entirety of the loan, including any interest payments or maintenance fees.
Common types of closed-end credit include mortgages and car loans. Both are loans taken out in lump sum for a specific period, during which the consumer is required to make regular monthly payments, usually of equal amounts.
The difference between closed-end credit and open-end credit is mainly in the terms of the debt and the debt repayment.
With many closed-end loans, the borrower may have to use the asset such as the home or car as collateral to guarantee repayment. For example, if a customer fails to repay an auto loan, the bank may seize the vehicle to recoup losses from the default.
Open-End Credit
Open-end credit is not restricted to a specific use. Credit card accounts, home equity lines of credit (HELOC), and debit cards are all common examples of open-end credit (though some, like the HELOC, have finite payback periods). The issuing bank allows the consumer to utilize borrowed funds in exchange for the promise to repay any debt in a timely manner.
This type of credit usually has a fixed period to borrow funds. At the end of this "draw period," you may be allowed to renew the credit line. If you are not allowed to renew, then the plan will require either payment in full of the outstanding balance or repayment over a fixed period.
The maximum amount available to borrow, known as the revolving credit limit,can change. Accountholders can request an increase, or the lender might automatically raise the limit for borrowers who have proved responsibility.
The lender might also reduce the limit if the customer's credit score has dropped drastically or a pattern of delinquent payment behavior begins. Some card companies allow cardholders to go above their limit in case of an emergency or if the overdraft is relatively small.
Line of Credit
A line of credit is a type of open-end credit. Under a line of credit agreement, the consumer takes out a loan that allows payment for expenses using special checks or a plastic card. The issuing bank agrees to pay on any checks written on or charges against the account, up to a certain sum.
Businesses, which can use company assets or other collateral to back the loan, often use this type of credit. Such secured lines of credit often have lower interest rates than unsecured credit, such as credit cards, which have no such backing.
What Is a Disadvantage of Closed-End Credit?
If you need to finance a project with an unpredictable end date, a closed-end line of credit may not be ideal for you. Open-end lines of credit have no set end date, so you can make withdrawals on a more flexible timeline than with an closed-end line of credit, which has a set end date.
What Is the Advantage of Open-End Credit?
With open-end credit, you typically get the flexibility to use the credit however you'd like. In contrast, many forms of closed-end credit like mortgages or auto loans require you to use the money for the specific purchase. With open-end credit, you can use the credit repeatedly as you pay it down and you pay interest on only the funds you use.
What Is an Example of Open-End Credit?
Revolving credit like credit cards or home equity lines of credit (HELOCs) are considered open-end credit because you can reuse the credit as you pay the debt down.
The Bottom Line
Lines of credit can be useful financial products, but whether an open-end or closed-end line of credit is right for you will depend on several factors. Consider consulting with a professional financial advisor to review all your options and how they apply to your specific situation.
FAQs
Closed-end lines of credit have an end date for repayment. Open-end lines of credit usually have no end date for repayment, or a very long term for revolving credit. A closed-end line of credit is commonly used in homebuilding, when an end date for construction is established.
What is the difference between closed-end credit and open-end credit? ›
The main difference between open-end credit and closed-end credit is this: Closed-end credit is taken out once, and has a specific repayment date; open-end credit, like credit cards, can be drawn from again and again, and there's no fixed due date for paying the balance in full.
What does open-end line of credit mean? ›
Key Takeaways. Open-end credit is a type of loan that the borrower can draw money from repeatedly up to a certain pre-approved limit. Unlike closed-end credit, it has no fixed end date for repayment. When the borrower repays some of the money they have borrowed, it restores that portion of their pre-approved limit.
What is an example of a closed-end credit? ›
Examples of closed-end loans include a home mortgage loan, a car loan, or a loan for appliances.
What happens when a credit line is closed? ›
When an account is closed, the amount of available credit decreases, which impacts your credit-utilization ratio — the amount you owe as a percentage of your total available credit. This ratio accounts for 30% of your credit score. Keeping your balances around 30% or less of your available credit is best.
Is an open-end line of credit good? ›
While open-end credit can offer you funds and flexibility, there can be some drawbacks. For example, it can be easy to over-spend knowing you have a certain amount of funds available to you at any point in time — don't forget, you have to pay this back, and sometimes with interest!
How does an open line of credit work? ›
A credit line allows you to borrow in increments, repay it and borrow again as long as the line remains open. Typically, you will be required to pay interest on borrowed balance while the line is open for borrowing, which makes it different from a conventional loan, which is repaid in fixed installments.
What happens if you open a line of credit and don't use it? ›
Some banks will charge a maintenance fee (either monthly or annually) if you do not use the line of credit, and interest starts accumulating as soon as money is borrowed.
What are the disadvantages of open-end credit? ›
Open-end lines of credit and loans do have their drawbacks: Unsecured open-end credit lines generally have higher interest rates and credit requirements than those secured by collateral. Annual Percentage Rates (APRs) for open lines of credit are always varied widely from one lender to another.
What are the three types of closed-end credit? ›
Types of Closed-End Credit There are three main types of closed-end credit: Installment Sales Credit, Installment Cash Credit, and Single Lump-Sum Credit.
installment credit. A good example of a closed-end credit is: a.)
What is an example of an open-end credit card? ›
Open-end credit.
With open-end, or revolving credit, loans are made on a continuous basis as you purchase items, and you are billed periodically to make at least partial payment. Using a credit card issued by a store, a bank card such as VISA or MasterCard, or overdraft protection are examples of open-end credit.
How long can a closed credit line stay on your credit report? ›
How long do closed accounts stay on your credit report? Negative information typically falls off your credit report 7 years after the original date of delinquency, whereas closed accounts in good standing usually fall off your account after 10 years.
Do I have to pay back a closed credit account? ›
Once your credit card is closed, you can no longer use that credit card, but you are still responsible for paying any balance you owe to the creditor. In most situations, creditors will not reopen closed accounts.
How long does a line of credit stay open? ›
How Lines of Credit Compare with Personal Loans and Credit Cards
| Lines of Credit vs. Personal Loans and Credit Cards | |
|---|
| Line of Credit |
|---|
| Account duration | Up to 15 years |
| Secured or unsecured | Both options available |
| Interest charges | Interest is charged only on outstanding balance |
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(Close-end credit) is a credit arrangement in which the borrower must repay the amount owed plus interest in a specific number of equal plans, usually monthly. (Open-ended) credit, credit is extended in advance of any transaction so that the borrower does not need to repay each time credit is desired.
What is the difference between open and closed accounts on your credit score? ›
Experts recommend keeping your credit utilization below 30%. While an open account may increase your credit utilization ratio, a closed account will reduce your available credit. Credit history: Your length of credit history or credit age is a measure of how long you've had a particular account or loan.
What is the difference between open-end and closed end mortgage? ›
With an open-end mortgage, you'll first finance your home purchase, then borrow more over time, at your discretion, to renovate the property. In essence, you're increasing your loan principal. This differs from a closed mortgage, which provides a set amount of funds and doesn't allow you to borrow more.
