Credit

The term “credit” refers to several phenomena in the financial sphere, but the main meaning usually alludes to a formal legal agreement between two parties, according to which one party provides another one with a certain sum of money or something valuable under the condition of a being repaid later with interest.

Another common meaning of the word “credit” in finance refers to a person’s or organization’s capability of borrowing money based on the history of their debt repayments. In this meaning, the word “credit” reflects an amount of money an individual or an organization can borrow next time. In this context, it’s possible to have good credit (a reliable credit record and, accordingly, a high possibility to be provided with another credit) or poor credit (any recorded difficulties with repaying debts, which might affect a bank’s decision on extending a credit).

In accounting, “credit” refers to a notation that records a transaction, which increases liability and revenue, and decreases expenses. It refers to entries typically placed on the right side of a check register and accompanied by debits (placed on the left side). In the accounting, all transactions, especially purchases, must be recorded in all companies accounts.

Credit as a system of lending and returning debt

The very word “credit” derives from Latin credere, which means “to trust, believe”. That reflects the inner principle of credit as a system of lending valuable objects with a postponed repayment. The history of credit has started a long time ago, and with the development of this concept it was formalized in a shape of a legitimate agreement suggesting penalties in case the debt isn’t returned on a specified date. There are usually two sides in this agreement, a lender or a creditor (the one who provides the funds) and a borrower or a debtor (the one who uses the money and promises to return it in a stated period of time).

Credit doesn’t always suggest direct borrowing of money from a bank. It often refers to a situation when a good or a service is purchased with a promise to pay for it later. This system of buying on credit includes the use of credit cards, one of the most popular forms of credit nowadays, which is organized the following way — a bank that issued the credit card used for a purchase, pays full price for the item bought on credit, and the user of the credit card repays the debt with interest to that bank later. Credit cards became extremely popular towards the end of the 20th century, and still remain in broad use today.

Credit as a representation of creditworthiness

Creditworthiness is an important measure that represents how a person or a company approaches and manages its debts, and creditworthiness directly correlates with a safety of extending a new credit to this entity. Credit bureaus and reporting agencies collect the data on a person’s credit history, and present it to banks or other credit institutions when they need to make to decide if it’s worth extending a credit to that person. That’s why it’s critically important to understand how credit works and manage it wisely to avoid possible complications in the future.

Credit types

Besides the aforementioned credit cards, credit may come in different forms. The most popular type of credit is financial credit extended by a bank, which includes such popular credit forms as mortgages, unsecured personal loans, car loans and others.

There is also a classification of credit types, according to which there are three main types of credit:

• Installment credit, which allows a borrower to take a certain amount of money, which is then repaid by a series of regular fixed payments during a stated period of time. After the full repayment, the credit account is closed and isn’t used for the following credit extensions, if there are any.
• Revolving credit, which suggests a regular cycle of borrowing and repaying some sums of money up to a set limit. Lines of credit and credit cards are popular forms of this type of credit. An account remains open if the debt is paid back in full and provides a possibility of further borrowing using the same account, until the borrower decides to close it.
• Open credit, which main characteristic is that monthly payments are often different each time. This type of credit is represented by service utility bills. While using public utilities, a consumer doesn’t directly buy it, but is given credit on it and then charged a bill at the end of a period, which often varies from time to time.

It’s also believed by some scholars that all financial operations are just different forms of credit.