Depending on the need, an individual or business may take out a line of credit that is either open-ended or closed-ended. The difference between these two types of credit is mainly in the terms of the debt and the debt repayment. Learn more about how each type of line of credit works.
Key Takeaways
- A line of credit allows you to withdraw the amount you need when you need it instead of receiving a lump sum.
- Closed-end lines of credit have an end date for repayment.
- Open-end lines of credit usually have no end date for repayment, or a very long term for revolving credit.
- A closed-end line of credit is commonly used in homebuilding, when an end date for construction is established.
Closed-End Credit
Closed-end credit includes debt instruments that are acquired for a particular purpose and a set amount of time. At the end of a set period, the individual or business must pay the entirety of the loan, including any interest payments or maintenance fees.
Common types of closed-end credit include mortgages and car loans. Both are loans taken out in lump sum for a specific period, during which the consumer is required to make regular monthly payments, usually of equal amounts.
The difference between closed-end credit and open-end credit is mainly in the terms of the debt and the debt repayment.
With many closed-end loans, the borrower may have to use the asset such as the home or car as collateral to guarantee repayment. For example, if a customer fails to repay an auto loan, the bank may seize the vehicle to recoup losses from the default.
Open-End Credit
Open-end credit is not restricted to a specific use. Credit card accounts, home equity lines of credit (HELOC), and debit cards are all common examples of open-end credit (though some, like the HELOC, have finite payback periods). The issuing bank allows the consumer to utilize borrowed funds in exchange for the promise to repay any debt in a timely manner.
This type of credit usually has a fixed period to borrow funds. At the end of this "draw period," you may be allowed to renew the credit line. If you are not allowed to renew, then the plan will require either payment in full of the outstanding balance or repayment over a fixed period.
The maximum amount available to borrow, known as the revolving credit limit,can change. Accountholders can request an increase, or the lender might automatically raise the limit for borrowers who have proved responsibility.
The lender might also reduce the limit if the customer's credit score has dropped drastically or a pattern of delinquent payment behavior begins. Some card companies allow cardholders to go above their limit in case of an emergency or if the overdraft is relatively small.
Line of Credit
A line of credit is a type of open-end credit. Under a line of credit agreement, the consumer takes out a loan that allows payment for expenses using special checks or a plastic card. The issuing bank agrees to pay on any checks written on or charges against the account, up to a certain sum.
Businesses, which can use company assets or other collateral to back the loan, often use this type of credit. Such secured lines of credit often have lower interest rates than unsecured credit, such as credit cards, which have no such backing.
What Is a Disadvantage of Closed-End Credit?
If you need to finance a project with an unpredictable end date, a closed-end line of credit may not be ideal for you. Open-end lines of credit have no set end date, so you can make withdrawals on a more flexible timeline than with an closed-end line of credit, which has a set end date.
What Is the Advantage of Open-End Credit?
With open-end credit, you typically get the flexibility to use the credit however you'd like. In contrast, many forms of closed-end credit like mortgages or auto loans require you to use the money for the specific purchase. With open-end credit, you can use the credit repeatedly as you pay it down and you pay interest on only the funds you use.
What Is an Example of Open-End Credit?
Revolving credit like credit cards or home equity lines of credit (HELOCs) are considered open-end credit because you can reuse the credit as you pay the debt down.
The Bottom Line
Lines of credit can be useful financial products, but whether an open-end or closed-end line of credit is right for you will depend on several factors. Consider consulting with a professional financial advisor to review all your options and how they apply to your specific situation.
FAQs
Closed-end lines of credit have an end date for repayment. Open-end lines of credit usually have no end date for repayment, or a very long term for revolving credit. A closed-end line of credit is commonly used in homebuilding, when an end date for construction is established.
What is the difference between open-end and closed-end lines of credit? ›
The main difference between open-end credit and closed-end credit is this: Closed-end credit is taken out once, and has a specific repayment date; open-end credit, like credit cards, can be drawn from again and again, and there's no fixed due date for paying the balance in full.
What is an open line of credit? ›
An open credit is a financial arrangement between a lender and a borrower that allows the latter to access credit repeatedly up to a specific maximum limit. Once the borrower starts making repayments to the account, the money becomes available for withdrawal again since it is a revolving fund.
What is the difference between open and closed HELOC? ›
Most home equity lines of credit (HELOCs) also offer revolving credit, though usually for a finite period. One type, the fixed-rate HELOC, combines features of both open- and closed-end credit lines. Unlike open-end lines of credit, closed-end lines of credit do have a fixed end point.
What is a closed-ended credit? ›
Closed-end credit is a loan or credit facility. Funds are dispersed in full when the loan closes and must be paid back, including interest and finance charges, by a specific date. Many financial institutions also refer to closed-end credit as installment loans or secured loans.
What is the main difference between open end and closed end funds? ›
Open-end funds are priced and traded once daily at the fund's NAV, which is calculated after the major U.S. exchanges close. Meanwhile, closed-end funds trade throughout the day at their current market price, which fluctuates throughout the trading session based on supply and demand.
What is the benefit of an open end line of credit? ›
The benefits of open-end credit
With credit cards, you have funds available to you to use whenever you would like, with the expectation that you'll make your payments on time. It acts as a flexible loan, one from which you can take out funds as you need them up until a fixed amount.
Does having an open HELOC hurt your credit? ›
In this regard, your HELOC has a lot in common with a credit card. It can have a small impact on your credit score when you apply for one, but a larger one if payments are late or missed. As additional debt, it can ding it — but can also boost it as an enhancement of your total available credit.
Can I sell my house with an open HELOC? ›
Yes, having a HELOC or home equity loan on your home does not usually complicate the home sale process. When you sell your home, proceeds from the sale will be used to cover the outstanding balance on your primary mortgage, HELOC or home loan, and any other liens on the property.
Is it bad to open a HELOC and not use it? ›
While having an unused HELOC can be advantageous in many ways, it's essential to be aware of the potential costs. Some HELOCs come with annual fees or maintenance fees, which you might still have to pay even if you don't use the credit line. The fees you could incur, even with an unused HELOC, include: Inactivity fees.
The drawbacks of closed-end credit include, but are not limited to: You only have access to the funds agreed upon between you and your lender — these funds don't replenish as you pay them back. Closed-end credit agreements come with fixed monthly payments.
What is open and closed-end credit examples? ›
Credit cards and lines of credit are examples of open-end credit and are also referred to as revolving credit. Open-end credit is different from closed-end credit, in which the borrower receives money in a lump sum and must pay it back by a fixed end date. Mortgages and car loans are examples of closed-end credit.
Is a closed credit account good or bad? ›
As TransUnion and Experian note, a closed account that shows a positive history of payments is likely to help your credit score. Generally, a closed account with negative history can continue to hurt your credit score for seven years.
What is the difference between open-end credit and closed-end credit quizlet? ›
One example of open end credit is credit cards. Closed end credit is a loan for a stated amount that must be repaid in full by a certain date. Closed end credit has a set payment amount every month. An example of closed end credit is a car loan.
What is the difference between open and closed accounts on your credit score? ›
Experts recommend keeping your credit utilization below 30%. While an open account may increase your credit utilization ratio, a closed account will reduce your available credit. Credit history: Your length of credit history or credit age is a measure of how long you've had a particular account or loan.
What is an open end mortgage line of credit? ›
An open-end mortgage is a type of mortgage that allows the borrower to increase the amount of the mortgage principal outstanding at a later time. Open-end mortgages permit the borrower to go back to the lender and borrow more money. There is usually a set dollar limit on the additional amount that can be borrowed.
