Open-End Credit Definition
Open-end credit, also called revolving credit, can be defined as a line of credit that gives the borrower a certain limit of credit and the ability to frequently borrow as little or as much of that money and repay any amount utilized below the set limit within a specified period.
To understand it better, a line of credit, as used in the definition, is a pre-approved amount of money that is extended by a lender and goes into a borrower’s special account to be drawn on a need basis. A credit line has an expiry date, and the borrower has the mandate to repay any principal used including the interest charged before the set date. However, if a borrower did not utilize the availed funds, there will be no penalties or interest charged.
There is often confusion between an open-end credit and a closed one. In contrast, a closed-end credit is when one requests a lender to borrow a specific amount of money, usually in a lump sum and paid up front, and then one is required to repay the principal and interest according to a regular payment schedule set by the lender. You can’t borrow frequently, and you don’t borrow less either like an open-end credit because of explicit terms which are not flexible.
A Little More on What is Open-End Credit
With an open-end credit the borrower has access to the whole credit limit, or full amount once approved. For instance, a lender approves a $50,000 line of credit, and the borrower withdraws $30,000. The payments to be made will, therefore, be $30,000 plus interest, without having to repay the $20,000 remaining in the account unless the same is utilized for something else.
Once a borrower pays off the $30,000 owed, the line of credit remains “open” for re-borrowing later, making the line of credit revolving in nature. This allows borrowers to access as much or as little funds as they chose depending on their current needs. Examples of open-ended credit include the following:
- Home equity lines of credit (HELOCs).
- All Credit cards including; department store, service station,bank-issued credit cards, and many others.
- Bank overdrafts for checking accounts.
- Travel and entertainment cards (T&E cards)
Open-end loans can be categorized as either secured or unsecured:
When approval of a loan does not require attachment of a valuable item as security, the loan is said to be unsecured. For instance, an unsecured credit card issued by a creditor with no piece of collateral attached in order to have access to a line of credit.
However, approval of any credit advanced solely depends on credit scores. Generally, a good credit score means minimal risk and can secure a higher credit limit for a prospective lender.
Besides the value of the collateral provided, a creditor will also base a loan limit for approval on credit scores of the lender. However, often the credit limit of a secured open loan will depend on the amount of money the borrower has deposited with the issuing bank if it is a secured credit card. Whereas, the value of the property attached is considered in regards to HELOCs. Failure to repay the loan advanced within the specified period could result in forfeiting the property used as security.
Open-End Credit Regulations
Open-end credits are regulated by Regulation Z rules. The regulations are enforced by the Consumer Financial Protection Bureau (CFPB) who ensure that stipulated regulations are adhered to by creditors. The rules provide guidelines on actions required during, after as well as before creating a credit line account.
Congress last made changes to Regulation Z in 2009 and subsequently 2010. The rules touch on specific guidance on disclosures, billing cycles and civil liabilities. Also, In case of an error resulting in substantial damages, there are precise rules for resolving the same.
When creating an open-ended credit plan, the creditor is mandated to disclose to the borrower each of the following items, to the extent that they apply to the line of credit:
- Whether there is a grace period provided or not.
- The conditions and method of calculating the balance upon which a finance charge may be imposed including any imposed minimum or fixed amount.
- The annual percentage rate as well as any other charges imposed as part of the account and how they are computed.
- A statement giving notice on how the creditor will secure the loan in regards to collateral.
- A statement of protection should be provided stipulating the obligations of both the creditor and the borrower.
After credit has been extended, the creditor is required to send statements in each billing cycle with the inclusion of specific information such as:
- Any outstanding balance at the commencement of a statement period.
- A brief description in terms of date, amount and the credit extensions during a specified period.
- During a statement period, the total amount of payments credited to the borrower.
- A breakdown of the finance charges billed on the account and the bill breakdown
- The total finance charge billed as an interest.
- The balance that is owing and a statement of how the creditor computed it.
- The account’s outstanding balance at the end of the period.
- The date by which payment must be made in order to avoid additional charges or penalties.
- The address where billing inquiries and queries are to be sent.
A Creditor’s liability for violating any of the above disclosure requirements as per regulation Z includes;
- Attorneys’ fees and costs incurred by the borrower when seeking legal redress.
- The actual cost of damage suffered by the borrower as a result;
- Twice the amount of any finance charges for transactions of between $100 and $1,000.
Some of the benefits of taking an open-end loan include:
- They provide flexibility in terms of borrowing and making payments.
- When faced with unexpected emergencies they come in handy.
- According to the University Federal Credit Union, HELOChaves generally have low- interest rates.
- In the case of an unsecured card or credit cards, it offers an additional payment option as well as giving account holders access to credit when cash is low.
- A secured credit card allows a consumer who doesn’t qualify for an unsecured credit card the opportunity to improve the credit score and qualify for an unsecured credit card in the future.
- A credit card allows one to make several purchases without worrying about cash. Also, one may benefit from loyalty programs available on purchases with a credit card.
Open-end loans and lines of credit do have their drawbacks:
- Unsecured open-end credits have higher interest rates and credit requirements compared to those secured by collateral.
- Annual Interest rates (APRs) for open lines of credit are always varied widely from one lender to another.
- Penalties for late payments and going over the credit limit can be severe. The lender may hike up your interest rate to as high as twenty-five percent and charge you late fees. If you go over the credit limit, you can also be assessed over-limit fees.
- It can lead to overspending by the account holder, leading to an inability to make payments.
- Misuse of a credit account can hurt a borrower’s credit score. It is estimated that the average household in the U.S. carries about $16,000 of credit card debt.
- The terms of the loan may change at any time. Your credit limit, for example, could be increased if your credit rating goes up, but can also be decreased if the lender believes you are a higher risk currently than when you first applied.
References for Open End Credit
Academic Research on Open-End Credit
Consumer knowledge of the costs of open‐end credit, Kinsey, J., & McAlister, R. (1981). Journal of Consumer Affairs, 15(2), 249-270. The paper analyses the 1977 mail survey of 1,330 Minnesota households that reported few American have actual knowledge of the interest rate charged by banks on open-end credit yet it was the most preferred choice of credit. The paper also discusses the possible reasons behind the lack of knowledge of the annual percentage rate (APR) of interest on open-end credit accounts.
Household Use of Open‐End Credit to Finance Risk, Eisenhauer, J. G. (1994). Journal of Consumer Affairs, 28(1), 154-169. The paper makes a comparison between insurance policies and open-ended credit and asserts that open-ended loans are better options in financing short term risks by American households.
Open End Credit Disclosure, Brandel, R. E. (1970). Open-End Credit Disclosure. Bus. Law., 26, 815. The paper outlines the necessary disclosures that should be made when considering taking up an open-ended credit facility.
Open-end Credit Under Truth-in-Lending, Clontz Jr, R. C. (1970). Am. UL Rev., 19, 236. The paper outlines a review of open-ended loan and the guidance concerning the same under the Truth in Lending Act.
Open-End Credit Disclosure Requirements Under the Truth in Lending Act, Landers, J. M. (1978). S. Cal. L. Rev., 52, 1005. The article analyses the disclosures that are required to be made by both the lender and the borrower when signing an open-end credit under the United State’s Truth in Lending Act.
Requirements and prospects for a new time to payoff disclosure for open end credit under Truth in Lending, Durkin, T. A. (2006). The paper looks at the requirements on the timelines for making payments to the open end loans and the disclosures that are mandatory by the lenders concerning the same.
Truth in Lending Simplification & Reform Act: Open-End Credit, The, Spivak, P. H. (1981). Colo. Law., 10, 3052. The paper discusses open-end credit under U.S Truth in Lending Simplification and Reform Act and tries to give a bright outlook of the regulations stipulated therein concerning such loans.
Open End Credit under the Truth in Lending Law-Some Forms to Guide the Dealer or Lender and His Lawyer, Townsend, R. B. (1969). Ind. Legal F., 3, 103.
The paper looks at the open end credit in regards to the Open End Credit under the truth in lending Law (TILS) and provides legal guidance in processing such loans and what lawyers, as well as lenders, should know.
Regulation Z Open End Credit Rules Comment Period Reopened, Lipsett, C., Medine, D., Gutierrez, F. H., & Steimer, N. (2005). J. Payment Sys. L., 1, 654. The paper discusses the stipulated rules as set out by Regulation Z in regard s to all types of open-end credit in the United States, be it secured or unsecured.
Consumer Credit Protection Act–Annual Rate Disclosure on Open End Credit Statements–Civil Liability–Bona Fide Errors–Class Actions–Ratner v. Chemical …, Hansen, C. J. (1972). Boston College Law Review, 13(6), 1511. The paper looks at the regulations on disclosures to open end credits according to the consumer credit protection act and possible result in civil liability, enforcement actions, and reimbursements.
Why bankers ration credit, Freimer, M., & Gordon, M. J. (1965). The Quarterly Journal of Economics, 79(3), 397-416. The paper discusses the factors that bankers use to determine interest rate charged on an open-end loan and consequently the varying rates observed across different banks.
Some factors affecting awareness of annual percentage rates in consumer installment credit transactions, Parker, G. G., & Shay, R. P. (1974). The Journal of Finance, 29(1), 217-225. The paper looks at factors that have led to little awareness of the annual percentage rates in consumer installment credit transactions and possible reasons behind such factors.