When funds are short and you need to make purchases, credit accounts allow you to buy what you need without having to save up the full amount. So many kinds of credit exist that knowing which one is right for you is not always easy. If you understand the most common variations of credit accounts, you can better choose what's right for you from all the loan products available.
Secured credit is the first type of loan account with which most people become familiar. As the name implies, something of value guarantees that the lender will not lose the full amount of the loan in the event of default. The most common kind of collateral is property, vehicles or business equipment; however, stocks, insurance and other securities are also options. These tangible assets provide lender security because if the loan is not paid, the lender has something to sell to recover the loss.
Unlike secured credit, unsecured credit involves no collateral. These credit accounts are also called signature accounts because only your signature is needed to complete the transaction. Be advised that unsecured credit often carries a higher rate of interest than secured loans because there is more risk for the lender in the event you default.
An example of how someone might use an unsecured loan or line of credit is to establish credit. While you will pay more than you borrowed, the benefits of creating a history of credit repayment can outweigh the cost of interest.
Lines of Credit
Lines of credit, also known as revolving accounts, offer flexibility that loans do not. After you sign the credit agreement, you are able to draw from the line of credit and repay it as many times as you like. Although credit cards are the most popular type, lines of credit that use checks or bank withdrawals are also available. As with loans, revolving credit can be secured or unsecured, depending on your contract.
Equity credit accounts, also known as second mortgages, allow you to pull money out of your home when you need it. Your equity in the home is equal to the home's value minus the outstanding mortgage. Not every state will let you borrow 100 percent of your equity, so check with your state's laws.
Equity credit differs from a standard secured line of credit or loan in that there's potential tax savings involved. Depending on your individual tax situation, you might be able to write off the interest charged. However, don't assume equity interest is tax-deductible without consulting a tax professional.
Special Credit Accounts
Mortgages are a more advanced kind of loan because of the complexity of contract and length of term. Terms of 15 years and 30 years are the most popular, and the interest can either be locked in for the duration or you can select an adjustable rate mortgage, or ARM, which allows you to take advantage of lower interest rates. However, an adjustable rate also means the interest rate can climb by as many percentage points as the contract allows.
Another special type of credit account is a student loan. The U.S. government guarantees these education loans, so the terms are more favorable than typical loans or lines of credit. Depending on your financial situation, the government might cover your interest payments while you're school. Other features unique to student loans include no payments until after you finish taking classes and your credit score is not a factor.