Consumer Credit & Commercial Credit: Separate Financing for Different Purposes

By on | General Debt & Loan Consolidation Information.

In the credit-oriented world in which we live in, American consumers and businesses have a plethora of choices in terms of loans and lenders. A wide variety of financing sources offer multiple forms of consumer credit and/or commercial credit. Lending institutions differ in the 1) types of loans they extend and their maturity dates, 2) interest rates and charges they impose, and 3) eligibility criteria that applicants must meet. Some forms of credit require a lump sum payment of interest and principal, whereas others must be repaid monthly or annually. Consumer or commercial loans may require prospective borrowers to pledge some form of security as guarantee of repayment, while others require solely the latter’s promise to pay. To make an educated decision on which creditors can furnish the type of financing that best suits their needs, consumers should familiarize themselves with the distinctions and defining features of consumer credit and commercial credit.

Consumer credit

This consists of a short-term loan designed to assist individuals in purchasing services or commodities primarily for household, family, or personal consumption, as opposed to business use. If the applicant is acting in a private capacity when seeking financing, then it is deemed to be consumer credit. Borrowers may utilize consumer loans to finance debt consolidation, home improvement, and the purchase of household appliances, automobiles, boats, recreational vehicles, a college education, and electronics, among other things. Consumer credit may be either unsecured or backed by funds in a bank account or an assignment of title. The rate of interest on consumer credit tends to be higher than that on business credit.

There are several categories of consumer credit:

1. Installment credit

Alternatively referred to as closed-end credit, installment credit requires consumers to repay the purchase price by making a series of equal periodic payments (usually monthly) of the principal and interest. Department stores offer this type of credit. Installment credit is widely utilized to finance the purchase of an automobile, furniture, and high-end electronics and appliances, such as computers, washers, and ovens. A specific monetary sum constituting the full purchase price of the goods is extended to the borrower, who must then repay the amount of credit received (principal) plus interest within a fixed time frame. If there is title to the property, the lender retains it until the borrower pays back the credit in its entirety.

2. Non-installment credit

This refers to consumer credit that is typically of short duration (i.e. thirty days) and that must be repaid in a lump sum. Also known as term loans, single-payment loans enable borrowers to purchase a product today and repay the principal and interest on a pre-determined date. Many department stores allow their regular customers to avail themselves of non-installment credit.

3. Open-end or revolving credit

The perfect embodiment of open-end credit are credit cards and charge accounts (i.e. Macy’s and Sears). With revolving credit, consumers may borrow additional funds when needed without having to complete a new application and can make partial or irregular payments. The balance must not exceed the line of credit or credit limit, which usually depends on the cardholder’ ability to repay the debt and his or her credit history. Upon being assigned a credit line, the debtor decides the amount of funds that he or she will utilize at any given time. Generally, borrowers make monthly or periodic payments subject to a pre-set minimum balance due established by the creditor. The minimum amount is usually either a percentage of the balance or a stipulated dollar figure. Debtors may choose to 1) pay the minimum amount, 2) pay more than the required minimum, or 3) repay the entire outstanding balance.

4. Home equity loan

This type of consumer credit, which relies on the equity that a borrower has in his or her home as security, is a convenient method of financing and offers competitive interest rates. Home equity loans may come in the form of installment loans or lines of credit (HELOCs).

5. Personal line of credit

Consumers may also apply for a personal line of credit, which allows them to withdraw funds at their convenience in order to deposit them into their checking account or purchase goods and services. The creditor furnishes the checks to the client, who may utilize them subject to the credit line’s limit. The interest charges depend on how long the funds have remained unpaid and how much the outstanding balance is.

Commercial credit

This category of financing comprises short-term credit that is extended to a business entity or individual for business purposes, such as increasing inventory. If a consumer applies for credit in a business capacity, the credit in question is commercial in nature. Also known as business credit, commercial credit involves an implicit understanding that the business will pay its supplier pursuant to the terms and conditions agreed upon at the time of purchase. Business entities may also secure bank loans from participating lenders. The amount of commercial credit provided is usually dictated by a number of factors including the following: (1) the corporation’s credit history, (2) the value of the assets capable of being utilized as collateral or converted into cash with ease, (3) the ratio of assets to the outstanding debt, and 4) the present worth of the holdings in the prospective borrower’s custody.

Commercial lenders offer a broader choice of credit options than do other creditors. Short-term loans, which are generally for a duration of less than one year, equip businesses that are temporarily cash-strapped with working capital. Upon converting their accounts receivable or inventory into cash, the businesses repay the loan in a lump sum. Intermediate loans, which boast a term of one to three years, are ideal for increasing capital, expanding, buying new equipment, and starting-up a business. Long-term loans are equally useful for business start-ups but also for purchases of fixed assets and for capital improvements. Debtors usually repay these loans on a quarterly or monthly installment basis. Businesses can also apply for a line of credit, which allows them to obtain funds repeatedly without needing to reapply, on the condition that borrowers stay within their credit limit. They will be required to submit financial statements to the lender once a year.

Business credit cards are also available for businesses and are ideal for small to medium-sized enterprises with less than 100 employees and an annual budget running under $1 million. Businesses with substantial employee expenses may consolidate their bills by applying for a central billing card. Other credit cards for businesses include commercial credit cards and corporate credit cards, the latter generally reserved for companies with more than 100 employees and a yearly income exceeding $1 million.

Prior to granting consumer or commercial credit, finance companies, retailers, and banks gauge an applicant’s credit-riskiness. They do so by obtaining a copy of the applicant’s consumer credit report from a credit reporting agency or credit bureau. Some of the information contained in credit reports includes the consumer’s payment history, borrowing activities, and public records such as monetary judgments, tax liens, and bankruptcies. Credit bureaus rely on this data to determine a borrower’s credit rating or credit score.