What is Consumer Credit?
Consumer credit is the amount of financing used by consumers to purchase non-investment services or products; typically, these purchases depreciate quickly—non-investment services or products include most material goods and are distinct from investment products like stocks, bonds or pieces of property.
The term, ‘consumer credit’ can vary in regards to definition, but the Federal Reserve in the United States is the predominant authority for issuing such definitions. As a result, the Federal Reserve defines consumer credit as any form of financing given to the individual consumer; the products purchased using this credit must be obtained for personal consumption and must not include any investment graded securities or assets.
Consumer credit can be defined as a stream of financing used to purchase particular goods in lieu of a direct payment; common forms of consumer credit include, financing for automobile purchases, personal loans (installment loans), credit cards, and retail loans. This; however, is a broad definition of consumer credit and more accurately corresponds to the act of lending to individual consumers.
Mortgages are predominantly excluded from being labeled as ‘consumer credit’ because the underlying product purchased is a primary asset—home values or properties are purchased as an investment due to the general rise in prices of homes and property.
In most instances, consumer credit is offered by financial institutions, such as financial intermediaries, banks or other lending institutions.
What is the cost of Consumer Credit?
The cost of consumer credit is the additional amount, meaning over the amount borrowed, that the individual consumer must repay. The cost of consumer credit also requires or includes interest payments, arrangement fees and a slew of other charges. As a result of these additional fees, the act of borrowing money or opening a credit line requires the individual—depending on credit score—to pay beyond the amount borrowed.
Some of the costs attached to opening a line of consumer credit are mandatory, meaning they are required by the lender as the integral part of the initial credit agreement. Other costs; however, are attached to credit insurance, which may be optional. The borrower, the individual consumer who opens up the credit line, will decide whether or not to pursuit optional costs such as credit insurance.
The costs of consumer credit must be understood before opening a credit line; often times individuals who are out-leveraged, who borrow more than they earn, are eventually crippled by mounting debts as a result of late payments or high interest rates.
Interest Rates and Fees associated with Consumer Credit:
Interest rates and other charges are presented in a variety of ways within a consumer credit agreement. The majority of legislative regimes force lenders to quote all mandatory charges in the form of an annual percentage rate. The APR is a calculation that promotes “truth in lending”; the delivery of the APR gives potential borrowers a clear measure of the true cost of opening up consumer credit lines. Furthermore, the delivery of such a percentage enables consumers to compare credit lines and evaluate which forms of financing are most desirable.
The APR is derived from the pattern of advances and repayments made during a consumer credit agreement; optional charges, such as insurance, are not included in the APR calculation.