What is consumer credit?
Consumer credit (also called consumer debt) is money individuals borrow to buy goods and services now and repay later. The term usually refers to smaller, unsecured loans rather than large, collateral-backed loans (for example, a mortgage is typically not treated as consumer credit because the property secures the loan).
Two main types
– Installment credit: A fixed loan amount is disbursed up front and repaid in regular, scheduled payments (installments) over a set term. Examples: many auto loans, personal loans, and some home-improvement loans. Interest and principal are packed into each payment.
– Revolving credit: A line of credit that you can draw on repeatedly up to an approved limit. You must make at least a minimum payment each billing cycle; any unpaid balance carries forward and accrues interest. The classic example is a credit card.
How consumer credit works (essentials)
– Lender provides funds (lump sum for installment; an open line for revolving).
– The borrower repays principal plus interest and any fees according to the agreement.
– Installment loans generally have fixed monthly payments and a set payoff date.
– Revolving accounts remain open while in good standing; balances can vary and may never be fully paid off if only minimums are paid.
– Lenders price credit based on factors such as credit history, collateral (if any), and loan type; unsecured revolving credit tends to have higher interest rates than secured or fixed-term installment loans.
Advantages and disadvantages
Advantages
– Smooths consumption: lets you buy now and pay over time.
– Convenience: credit cards are widely accepted and can offer protections and rewards.
– Emergency liquidity: credit can cover urgent, unexpected expenses.
– Credit history: responsibly used consumer credit builds a track record that helps future borrowing.
Disadvantages
– Cost: high interest rates on revolving credit can make small balances expensive if carried month-to-month.
– Credit-score risk: missed or late payments can lower your credit score.
– Debt accumulation: low minimum payments on revolving accounts can keep you in debt longer and increase total interest paid.
– Some consumer credit is unsecured, so lenders may charge higher APRs to offset risk.
Does an installment loan hurt your credit?
An installment loan can lower your credit score if you miss payments. Conversely, making all payments on time generally helps build a positive repayment record. The effect depends on your wider credit profile.
What’s a main downside of revolving credit?
The principal downside is cost from high APRs when balances are not paid in full. Repeatedly paying only the minimum can let interest compound and keep principal high.
Examples of consumer credit
– Credit cards (revolving)
– Auto loans (often installment)
– Personal loans (installment)
– Student loans (may be installment)
– Mobile-home loans and small home-improvement loans (often installment)
Note: mortgages are normally excluded from “consumer credit” classification because they are secured by real estate.
Quick numeric examples (worked)
1) Installment loan monthly payment example
– Loan: $5,000 personal loan
– APR: 8% annual
– Term: 3 years (36 months)
Use the
amortizing loan formula:
Payment = P * r / (1 − (1 + r)^−n)
where
– P = principal (loan amount)
– r = monthly interest rate = APR / 12
– n = number of monthly payments
Worked numbers
– P = $5,000
– APR = 8% → r = 0.08 / 12 = 0.0066666667
– n = 36 months
Compute (1 + r)^−n ≈ (1.0066666667)^−36 ≈ 0.7873
Payment = 5,000 * 0.0066666667 / (1 − 0.7873) ≈ 33.3333 / 0.2127 ≈ $156.71 per month
Totals
– Total paid = $156.71 × 36 ≈ $5,641.56
– Interest paid = $5,641.56 − $5,000 ≈ $641.56
Takeaway: For an installment loan, the monthly payment formula gives a fixed payment that covers both interest and principal; total interest depends on APR and term length.
2) Revolving credit (credit-card) mini worked example — demonstrating the cost of minimum payments
Scenario
– Balance = $2,000
– APR = 20% → monthly rate r = 0.20 / 12 = 0.0166667 (1.66667%)
– Minimum payment = 2% of balance (common bank rule; some cards use a different formula)
Month 1
– Interest = 2,000 × 0.0166667 = $33.33
– Minimum payment = 2,000 × 0.02 = $40.00
– New balance = 2,000 + 33.33 − 40.00 = $1,993.33
Month 2
– Interest = 1,993.33 × 0.0166667 ≈ $33.22
– Minimum payment = 1,993.33 × 0.02 ≈ $39.87
– New balance ≈ 1,993.33 + 33.22 − 39.87 = $1,