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Credit (from Latin credit, "(he/she/it) believes") is the trust which allows one party to provide money or resources to another party where that second party does not reimburse the first party immediately (thereby generating a debt), but instead promises either to repay or return those resources (or other materials of equal value) at a later date. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.
The resources provided may be financial (e.g. granting a loan), or they may consist of goods or services (e.g. consumer credit). Credit encompasses any form of deferred payment. Credit is extended by a creditor, also known as a lender, to a debtor, also known as a borrower.
Credit does not necessarily require money. The credit concept can be applied in barter economies as well, based on the direct exchange of goods and services. However, in modern societies, credit is usually denominated by a unit of account. Unlike money, credit itself cannot act as a unit of account.
Movements of financial capital are normally dependent on either credit or equity transfers. The global credit market is three times the size of global equity. Credit is in turn dependent on the reputation or creditworthiness of the entity which takes responsibility for the funds. Credit is also traded in financial markets. The purest form is the credit default swap market, which is essentially a traded market in credit insurance. A credit default swap represents the price at which two parties exchange this risk – the protection seller takes the risk of default of the credit in return for a payment, commonly denoted in basis points (one basis point is 1/100 of a percent) of the notional amount to be referenced, while the protection buyer pays this premium and in the case of default of the underlying (a loan, bond or other receivable), delivers this receivable to the protection seller and receives from the seller the par amount (that is, is made whole).
Types of credit
In commercial trade, the term "trade credit" refers to the approval of delayed payment for purchased goods. Credit is sometimes not granted to a buyer who has financial instability or difficulty. Companies frequently offer trade credit to their customers as part of the terms of a purchase agreement. Organizations that offer credit to their customers frequently employ a credit manager.
Consumer debt can be defined as "money, goods or services provided to an individual in the absence of immediate payment". Common forms of consumer credit include credit cards, store cards, motor vehicle finance, personal loans (installment loans), consumer lines of credit, retail loans (retail installment loans) and mortgages. This is a broad definition of consumer credit and corresponds with the Bank of England's definition of "Lending to individuals". Given the size and nature of the mortgage market, many observers classify mortgage lending as a separate category of personal borrowing, and consequently residential mortgages are excluded from some definitions of consumer credit - such as the one adopted by the Federal Reserve in the US.
The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay. It includes interest, arrangement fees and any other charges. Some costs are mandatory, required by the lender as an integral part of the credit agreement. Other costs, such as those for credit insurance, may be optional; the borrower chooses whether or not they are included as part of the agreement.
Interest and other charges are presented in a variety of different ways, but under many legislative regimes lenders are required to quote all mandatory charges in the form of an annual percentage rate (APR). The goal of the APR calculation is to promote "truth in lending", to give potential borrowers a clear measure of the true cost of borrowing and to allow a comparison to be made between competing products. The APR is derived from the pattern of advances and repayments made during the agreement. Optional charges are usually not included in the APR calculation.
- Commercial credit reporting
- Credit bureau
- Credit history
- Credit risk
- Credit score
- Credit theory of money
- Default (finance)
- Financial literacy
- Mutual credit
- Payday loan
- Person-to-person lending
- Predatory lending
- Revolving credit
- Risk-return spectrum
- Settlement (finance)
- Social credit
- Subprime lending
- Credit (def. 2c). Merriam Webster Online. Retrieved 5 March 2015.
- Simkovic, Michael (2016). "What Can We Learn from Credit Markets?". Proceedings of the 93rd Annual Meeting of the American Law Institute.
- O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 512. ISBN 0-13-063085-3.
- Ingham, G. (2004). The Nature of Money. Polity Press. pp. 12–19.
- Finlay, S. (2009). Consumer Credit Fundamentals (2nd ed.). Palgrave Macmillan.
- Logemann, Jan, ed. (2012). The Development of Consumer Credit in Global Perspective: Business, Regulation, and Culture. New York: Palgrave Macmillan. ISBN 978-0-230-34105-0.
Quotations related to Credit at Wikiquote