In this article:
Borrowing money is often a necessity, whether you need a loan to buy a home or a credit card to stay afloat amid emergency expenses. Before you apply, it's important to understand that credit usually comes in one of two forms: open-end and closed-end. Each form works differently, and has its own pros, cons, fees and terms. They can also impact your credit differently.
If you take out an installment loan, such as an auto loan, this is a form of closed-end credit with a fixed interest rate and payment. Open-end credit, on the other hand, is revolving credit that allows you to continually access money as you make payments and only pay interest on what you use.
How Open-End Credit Works
With open-end credit, you receive a credit line with a limit that you can draw from as needed, only paying interest on what you borrow. Common examples of open-end credit are credit cards and lines of credit. As you repay what you've borrowed, you can draw from the credit line again and again. Depending on the product you use, you might be able to access the funds via check, card or electronic transfer.
With some forms of open-end credit, there's no end date. For example, with a credit card, you can repay your balance and reborrow as long as the card issuer allows you to continue using the credit product. Essentially, if the card issuer remains in business and the account remains in good standing, your open-end credit could be used indefinitely. Some lines of credit, like personal lines of credit, typically do have structured draw periods and repayment periods, but you still usually have years to borrow and repay repeatedly.
Because open-end credit is revolving, it shows up on your credit report differently than closed-end credit. Both your maximum credit line and balance factor into your credit utilization rate and can either help or hurt your credit depending on how you use the account.
Open-end credit is a contrast to closed-end credit, which is more commonly called an installment loan. Say you take out an auto loan; you (or the dealership, in this case) receive a lump-sum payment upfront for a certain amount that you then repay with interest over a set term in fixed installments. Once the balance is fully paid off, the account will be closed and can't be used to borrow more money.
Common Examples of Open-End Credit
Credit cards are the most common type of open-end credit you'll encounter. Most credit cards are unsecured, meaning no deposit or collateral are required (secured cards require a security deposit that typically becomes the card's credit limit). The interest rate and minimum monthly payment on credit cards can vary.
Another type of open-end credit is a line of credit, such as a personal line of credit, business line of credit or home equity line of credit (HELOC). Personal and business lines of credit may be either secured or unsecured, though you can obtain secured ones for a better interest rate.
A HELOC is always secured since your home serves as collateral, which could mean an affordable interest rate—but your home is at risk if you fail to repay.
Open-End Credit vs. Closed-End Credit
Both forms of debt have their advantages and drawbacks. The choice of which type of credit to use will ultimately come down to why you need to borrow money and how flexible your purchase and repayment needs are.
Open-End Credit Pros and Cons
The best perk of open-end credit is its flexibility. Since you can borrow from the account repeatedly, you can use it for many different transactions over time and in varying amounts. It might also be convenient in case of emergency since you already have access to the available credit.
Plus, with open-end credit, there aren't fixed repayments. Instead, you only have a minimum payment and can carry a balance for a while if money is tight (though you'll pay for the convenience in the form of interest). The flip side of this flexibility is less predictability. Because interest rates are often variable on revolving credit, and you pay based on what you borrowed, your payments could range drastically and make it harder to budget. There may also be annual fees with open-end credit accounts.
Keep in mind that costs also vary by the type of open-end credit you're using; for example, interest rates on lines of credit are often much lower than on credit cards. Additionally, not all financial institutions offer lines of credit.
Closed-End Credit Pros and Cons
Closed-end credit isn't very flexible. You apply for a specific amount, receive that amount and repay it in fixed monthly payments. You can't later ask for more money, or pay a lower amount one month because you need to take care of other expenses. This makes it best-suited for a single, large, predictable purchase such as a house, car, medical expense or debt consolidation.
The positive side of closed-end credit is it offers predictability and stability. With no annual fees and a fixed interest rate and term, you know how much your payment will be each month and can budget accordingly. And when you've finished paying it off, that debt is done with. These forms of credit are typically more straightforward and with fewer fees.
The Bottom Line
Closed-end and open-end credit offer different ways to borrow money, and the right choice comes down to what the funds are for, how predictable your expenses are and how much flexibility you need. Your credit is impacted somewhat differently by each type, though ultimately, responsible use with either can help improve your credit score over time.
Keep in mind that your credit score also helps determine which type of financing you can get approved for and what terms you receive. The higher your credit score, the greater your chances of approval, and the lower your interest rate may be. With Experian's comparison tool, it's free to get personalized offers for personal loans or credit cards based on your credit score.