Credit Terms Meaning
Credit Terms is defined as the payment terms and conditions made by the lending party in exchange for the credit benefit. Examples include credit given by suppliers to buyers of products and the terms maybe 3/15, net 60, which simply means that even though the amount is due in 60 days, the buyer can avail an additional discount of 3% if they pay within 15 days.
Factors of Credit Terms
There are basically 4 factors to any type of credit terms in the market.
#1 – Time
The beneficiary is allowed a time benefit (which is why it is not cash payment), such that the transaction can be settled before the actual payment. Typically, the time limits are set before the transaction is made.
#2 – Amount
The amount to be availed by the beneficiary is put to a limit based on their credibility. This credibility is first verified by the credit-providing party based on credit scores, ratings, and other performance-related indicators. Better the credibility higher is the credit limit.
#3 – Interest
Based on the type of credit availed, there is a charge posed against such benefit to the beneficiary. For example, Mr A takes a car loan of $100,000 from ABC Bank for 5 years, which is to be repaid along with 10% interest /annum. This interest provision is the fees charged by the bank in exchange for the credit facility they provide. In some cases like credit cards, there is a one-time fee charged by the credit card provider to the beneficiary party. In other cases like post-dated checks, there may not be any such charge imposed to the payer, however, the deal may get settled only after the amount gets settled in the bank. In this case, there is no cash charged, however, the delay in availing of services can be considered as payment in kind.
#4 – Default Terms
Due to the risk involved in repayments, the credit providing party always has certain terms related to default. These terms include interest charges, late payment fees, excess payments, or in some cases termination of a contract. For example, in the above case of Mr. A’s car loan, the bank poses a condition where if Mr. A defaults, interest at the rate of 2% month shall be charged from the due date until payment of such amount.
Credit Terms with Respect to Modes of Payment
Below are credit terms vis-a-vis payment modes.
#1 – Post Dated Check
- The deal may be settled only after the transaction is settled between the payee and payer banks.
#2 – Credit Cards
- Time benefit of particular days by the respective service provider within the billing cycle.
- No extra charge on the transaction amount if the bill is paid within due date.
- Amount paid after the due date (and sometimes beyond the agreed upon grace period), interest shall be levied.
- Credit Card rental, typically on an annual basis, to be paid as decided between provider and service availing party.
#3 – Secured Loans (Debts)
- Interest charged to the borrower at a periodic rate generally prevalent in the markets.
- In case of default, the borrower is charged with an additional late charge amount on the due amount until paid.
- Collateral is kept as security by the lender until complete repayment by the borrower.
#4 – Unsecured Loans (Debts)
- Unsecured loans have a higher degree of default risk by the borrower, hence the terms are more stringent than the secured loans, sometimes customized between the lender and the borrower based on the transaction.
- As there is no collateral in such types of loans, the interest repayment rate is higher than secured loans.
- Default terms are more stringent, sometimes even lead to cancellation of contracts or recovery from the sale of the borrower’s other assets.
#5 – Service-Related Credit Terms
- Credit terms can be created for service imparted as well. For example, a painting company would get paid only after the job is completed, or, an employee in a company gets paid only upon the end of the month or cycle.
- Most of the times, for any service related credits, there are contracts made by the provider with the party who avails the service.
Relevance and Uses of Credit Terms
The Buyer of Credit is Seller of Risk
The party which avails credit from this service provider transfers its risks to the service provider in exchange for some charges by the provider. Hence it is free from credit risk which benefits them to make the required transaction in time without delay. On the other hand, the service provider is said to be the buyer of such risk.
Fluent Circulation of Money in Markets
With the help of such a credit system in the economy, there is a lesser chance of blockage of money in circulation, unless the economy gets into a serious crisis. If the repayment risks are also taken care of, then this system leaves very few chances of failure.
Option to the Cash System
This system acts as an option to the preliminary cash system.
Credit Terms have evolved dynamically in money markets and is now at a very advanced stage with every service provider trying to provide more and better services in the market. Today, almost every materialistic item can be bought on credit, and there are many easy options to avail the same. However, we should always keep in mind that the success of this system depends completely on the credit terms set by the service providers and how well they are implemented during the respective term.
This has been a guide to what is Credit Terms and its meaning. Here we discuss the top 4 factors of Credit Terms and how it varies vis-a-vis the modes of payments. We will also discuss the relevance and its uses. You can learn more about from the following articles –