Guide to Closed-End Credit: What It Is And How It Works

Closed-end credit is a loan agreement that requires borrowers to repay the loan in full by a specified date. A closed-end credit agreement generally includes a payment schedule that defines the number of payments a borrower is expected to make over the life of the loan.

Examples of closed-end credit include personal loans, auto loans, and mortgages. A closed-end credit agreement may require borrowers to make a fixed monthly payment that goes toward repaying the principal loan amount and any interest charges. Below we describe how closed-end credit works and how it differs from open-end credit.

What Is Closed-End Credit?

Closed-end credit is any nonrevolving consumer lending product that provides borrowers with an installment loan. This form of credit features a prearranged payment schedule that usually requires the borrower to make monthly payments over the life of the loan.

Closed-end credit is an extension of credit that must be repaid in full by a specified date. Examples of closed-end credit include personal loans, car loans, mortgages, and student loans. 

How Does Closed-End Credit Work?

Closed-end credit works by requiring borrowers to repay a loan in full by a specified date on a prearranged payment schedule. Borrowers may sign a loan agreement that outlines the terms and conditions of the closed-end credit transaction between the borrower and lender.

A 48-month personal loan, for example, would require the borrower to make 48 monthly payments on the loan. A $5,000 personal loan with a 48-month repayment schedule and 12% annual interest rate would cost you $131.67 every month and about $6,320 over the life of the loan.

Closed-End Credit Payment Terms

Closed-end credit payment terms refer to the fixed repayment schedule and conditions set by the lender. These typically include:

• Loan term: A set period (e.g., 12 months, 5 years, or 30 years) to repay the loan.

• Fixed payments: Regular monthly installments covering principal and interest.

• Interest rate: Can be fixed or variable, affecting total repayment cost.

• Loan amount: A predetermined sum that must be repaid in full.

• No reuse of credit: Unlike revolving credit, funds cannot be re-borrowed once repaid.

Borrowers must make payments on time to avoid late fees or penalties.

Closed-End Credit Example

As mentioned above, a 48-month personal loan of $5,000 featuring a 12% annual percentage rate of interest is a closed-end credit example. The prearranged 48-month repayment schedule in this case would require the borrower to pay $131.67 every month and about $6,320 over the life of the loan.

Despite the prearranged payment schedule, borrowers may make larger periodic payments than required on a closed-end credit account. Some lenders may charge prepayment penalties if you pay off the loan early, but many lenders do not penalize borrowers for paying off their loans early.

Borrowers can minimize their interest charges by paying off their loans early. Failing to make a required loan payment when due may constitute a default, and nonpayment delinquencies of 30 days or more could severely damage your credit.

Are Personal Loans Closed-End Credit Loans?

Yes, personal loans are a closed-end credit example. A personal loan provides borrowers with a lump sum of money, and borrowers are generally expected to repay the loan in full over a set period. Payments on a closed-end credit product are usually made in monthly installments.

Personal loan agreements may require the borrower to make a fixed payment each month that goes toward repaying the principal loan amount and any interest charges. Some lenders may allow the borrower to pay off the loan early without charging prepayment penalty fees.

Secured Closed-End Credit vs Unsecured Closed-End Credit

Closed-end credit can be secured with collateral or unsecured, meaning collateral is not required. The table below highlights the differences between secured and unsecured closed-end credit:

How Is Closed-End Credit Different From Open-End Credit?

Closed-end credit is a nonrevolving lending product, while open-end credit is a revolving credit product. When borrowing money, consumers may have a repayment plan presented either as installment or revolving credit. Installment loans represent closed-end credit, whereas revolving credit represents open-end credit.

A revolving credit account, such as a credit card or personal line of credit, allows the consumer to make repeated transactions up to the credit limit. Revolving credit replenishes automatically whenever you make repayments on the open-end account.

Nonrevolving credit does not replenish. What happens with nonrevolving credit is that your closed-end credit account effectively closes once you repay the loan in full. Closed-end credit must be repaid in full by a predetermined date, also known as the loan maturity date.

Open-end credit must be repaid over time and generally gives consumers the option of making minimum monthly payments or greater each billing cycle. Open-end credit account holders have no obligation to use their available credit and can maintain their accounts indefinitely.

Recommended: Open-End vs Closed-End Credit

Pros and Cons of Closed-End Credit

The below table highlights some of the pros and cons of closed-end credit:

Closed-End Personal Loan

A closed-end personal loan is a consumer lending product that provides borrowers with a lump sum of money and a payment schedule for repaying the loan. All personal loans, whether secured or unsecured, are closed-end credit.

There are many pros and cons of a personal loan. Personal loans can promote debt consolidation, they offer predictable monthly payments, and they can be used for a variety of purposes. On the flipside, monthly payments on a personal loan could be higher than minimum credit card payments, fees can be high, and collateral may be required if your credit score is poor.

How Closed-End Credit Affects Your Credit Score

Applying for closed-end credit could cause your credit score to drop several points if the lender conducts a hard pull inquiry into your credit report. Closed-end credit could also damage your credit if you make late payments or veer deep into nonpayment delinquency.

Closed-end credit can help build your credit if you make on-time payments over the life of the loan. Nonrevolving credit, including online personal loans and other closed-end consumer lending products, can broaden your credit history.

The Takeaway

Closed-end credit is a structured financing option that provides borrowers with a lump sum that must be repaid over a fixed term through scheduled payments. Unlike revolving credit, it does not allow for repeated borrowing once funds are repaid.

Examples of closed-end credit include mortgages, auto loans, student loans, and personal loans.

If you’re looking for a personal loan, Lantern by SoFi can help you find and compare personal loan options. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.

Learn more today.