The word credit originates form a Latin word known as “credere” which means trust, faith and belief. A credit transaction involves two parties who are the lender and the borrower where goods and services are exchanged and payment expected at a future date.
Credit is classified into three categories which are, Consumer credit, Trade credit and export Credit.
A consumer credit agreement is a form of credit-debt relationship that reflects a formal monetary commitment between two parties that is recognized as a legally binding contract. One party the lender also known as a creditor provides funds in the form of cash, goods or services, to the other who is known as the borrower or a debtor, who undertakes a commitment to repay the debt at a future date. Consumer credit covers only credit agreements where the debtor is an individual.
The responsibility of the debt in consumer credit lies with an identifiable person and not an institution or a company, which differentiates consumer credit from the other two forms of credit which are Trade and Export Credit. Despite of the differences in all form of credit, general principles by which credit is granted and governed are universal and are applied in all the three forms of credit.
Consumer credit takes different forms which can be categorized based on the following features:
- Secured or unsecured. Credit is secured if the credit agreement details specific assets known as a collateral the lender can take in lieu of the debt should the borrower default; e.g. home or car. One without a collateral is classified as unsecured.
- Amortized or balloon. Credit is amortized if debt is repaid in installments covering both interest and capital, so that by the end of the agreement the debt has been fully repaid. With balloon credit the debt is repaid in full at the end of the agreement. Interest may be paid at regular intervals throughout the agreement or as a single payment at the end. Credit agreements where irregular repayments are made are also defined as balloon
- Fixed sum or running account. A fixed sum credit agreement is where a known amount of credit is advanced Once the debt has been repaid the agreement is terminated. With a running account agreement, the amount of credit is not set when the agreement is made, but a credit facility is made available. The outstanding debt fluctuates as new credit is extended and repayments are made. Running account agreements are also known as open-ended credit agreements or revolving credit This is common with credit cards.
- Unrestricted or restricted. If credit is obtained in the form of money, that can be spent however the borrower wishes, then the credit is unrestricted. If credit is restricted it can only be used to obtain a limited range of goods or services; that is, credit is provided to buy specific items which are then paid for on credit terms.
- Credit sale, conditional sale or hire-purchase. These features apply only to restricted credit agreements.
- Goods sold on a credit sale basis become the immediate property of the customer. The merchant cannot reclaim/seize the goods if the customer subsequently fails to repay their debt.
- Conditional sale, ownership of goods transfers to the borrower only when the terms of the agreement have been complied with. Therefore, the lender can repossess the goods should the terms of the agreement be broken.
- Hire-purchase is similar to conditional sale, but the important difference is that the customer is only hiring the goods with an option to buy at the end of the agreement. The hirer can choose not to exercise their option to buy and return the goods. With a conditional sale the borrower is committed to the purchase.
- Debtor-creditor or debtor-creditor-supplier agreement. A debtor -creditor agreement exists where the transaction that led to the creation of the credit agreement involves only the debtor and the creditor. A debtor-creditor-supplier agreement exists when goods or services are purchased from a merchant, with credit provided by a third party. The purchaser is then indebted to the third party not the merchant. This is common with LPO financing arrangements.
Players in the consumer credit are banks, Savings and Credit Cooperatives (SACCOs), Microfinance, Digital lenders, finance houses, retailers etc.
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