A loan can be closed-end or open-end. A closed-end loan is frequently an installment loan in which the loan is issued for a specific amount and repaid in installment payments on a predetermined schedule. An auto loan is an example of this. An open-end loan is a revolving line of credit issued by a lender or financial institution. It is available in two varieties, each with unique characteristics that can benefit the borrower. In this article, we’ll see the meaning of an open-end loan with an example. Also, we’ll briefly discuss the difference between an open-end and a closed-end loan.
Meaning of Open-End Loan
An open-end loan is a preapproved loan between a financial institution and a borrower that can be used repeatedly up to a certain limit and then paid back before payments are due.
The preapproved amount will be specified in the lender-borrower agreement. An open-end loan is also known as a line of credit or a revolving line of credit.
Open-end loans, such as credit cards, differ from closed-end loans, such as auto loans, in terms of how funds are distributed and whether a consumer who has begun to pay down the balance can withdraw the funds again.
Understanding Open-End Loans
Borrowers benefit from open-end loan agreements because they have more control over when and how much they borrow. Furthermore, interest is usually not charged on the portion of the line of credit that is not used, which can result in interest savings for the borrower when compared to an installment loan.
Open-end credit frequently takes the form of a loan or a credit card. Credit cards are the most common example of an open end loan in the consumer market because they provide flexible access to funds that are immediately available once a payment is received. Another popular loan type in the consumer market is a home equity line of credit, which allows borrowers to access funds based on the amount of equity in their homes or other property.
A line of credit loan may use various metrics to determine the maximum amounts on the business side. These measures can include information about the value or revenue of a company, as well as collateral such as real estate assets and the value of other tangible goods held by the organization.
Particular Considerations
A line of credit is not the same as a closed-end loan. The primary distinction between a line of credit and a closed-end loan in both the consumer and business sectors is how the funds are initially distributed and whether they can be reused as payments. While both products have a maximum dollar amount allowed, known as the credit limit, the loans work differently.
A closed-end loan, also known as an installment loan, provides the borrower with the entire loan amount up front. The amount owed decreases as payments are made toward the balance, but those funds are unlikely to be withdrawn a second time. This is what prevents a closed-end loan from being classified as a revolving line of credit.
When a line of credit is granted, the entire loan amount is immediately available. Borrowers can access as much or as little money as they want based on their current needs. Borrowers can withdraw funds as the balance owed is paid down, making the line of credit revolving in nature.
Open-end loans, such as credit cards, differ from closed-end loans, such as vehicle loans, in terms of how money are transferred and whether a consumer who has begun to pay down the balance can take the funds again.
Types Of Open End Loan
Unsecured Open-End Loan
An unsecured open-end loan is a line of credit that is not secured by any collateral. An example of this type of loan is an unsecured credit card. The approval of the line of credit is primarily based on the borrower’s creditworthiness. Because there is no physical item to which the credit is attached, lenders consider an applicant’s credit score when issuing an unsecured credit card. In general, the higher the approved credit limit, the more creditworthy the lender considers the borrower to be.
Secured Open-End Loan
A secured open-end loan is a credit line that is secured by or attached to some type of collateral. Secured, open-end loans include secured credit cards and home equity lines of credit. In addition to the borrower’s creditworthiness, the lender will rely on the approved credit limit amount on the value of the collateral item. A secured credit card’s credit limit, for example, is frequently equivalent to the amount of money the borrower has on deposit with the issuing bank. The value of home influences how much of a credit line a lender would authorize for HELOCs. In contrast to an unsecured open-end loan, failing to repay a secured open-end loan may result in the loss of the property used as collateral.
Advantages of an Open-End Loan
Both types of open-end loans have advantages. Lines of credit are adaptable, which means you can borrow as much or as little as you need up to your credit limit. They are also useful in the event of an unexpected emergency. According to University Federal Credit Union, HELOCS typically have low-interest rates. When it comes to credit cards, an unsecured card provides an additional payment option and gives consumers access to credit when they are short on cash.
A secured credit card provides an opportunity for a consumer who does not qualify for an unsecured credit card to rebuild his credit. Proper account management, such as making on-time payments and keeping credit card balances low, can help to improve a credit score over time. This may allow the borrower to qualify for an unsecured credit card in the future. Thus, freeing up cash reserves that were previously utilized for the secured credit card.
Open-End vs. Closed-End Loan
Closed-end loans require the borrower to repay the entire loan amount in installments after receiving the complete loan amount upfront.
However, unlike open-end credit, which allows the borrower to withdraw the funds again after repayments, closed-end credit does not allow the borrower to withdraw the cash a second time. This is why open-end credit is also known as a revolving line of credit.
Open End Mortgage
An open-end mortgage is one that allows the borrower to increase the amount of mortgage principal owed at a later date. Borrowers with open-end mortgages can return to the lender and borrow more money. The additional amount that can be borrowed usually has a monetary limit.
Understanding An Open-End Mortgage
A delayed draw term loan is similar to an open-end mortgage. It also has revolving credit-like features. Open-end mortgages are distinct in that they are a loan agreement secured by a real estate property, with funds going solely toward investment in that property.
The application process is similar to that of other credit products, and the loan terms are determined by a borrower’s credit score and credit profile. Co-borrowers may have a better chance of getting an open-end mortgage if they have a lower default risk.
Open-end mortgages can provide a borrower with a maximum principal amount that they can obtain over a specified time period. The borrower can use a portion of the loan value approved for to cover the costs of their home. Because the borrower is only required to make interest payments on the outstanding balance, taking only a fraction allows them to pay reduced interest. In the case of an open-end mortgage, the borrower can receive the loan principal at any time stipulated in the loan terms. The amount of money that can be borrowed may also be linked to the value of the residence.
An open-end mortgage differs from a delayed draw term loan in that the borrower is usually not required to complete any set milestones in order to acquire more cash. An open-end mortgage varies from revolving credit in that the funds are often only available for a limited time. The terms of revolving credit stipulate that the funds remain available indefinitely, with the exception of a borrower’s default.
Drawdowns from available credit in an open-end mortgage can also only be used against the secured collateral. As a result, payments must be directed toward the real estate property in which the lender holds title.
The Benefits of an Open-End Mortgage
An open-end mortgage is favorable for a borrower who qualifies for a larger loan principle amount than is required to purchase a home. An open-end mortgage might offer a borrower a maximum amount of credit at a low interest rate. The borrower has the option of drawing on the loan principal to cover any property expenditures that emerge during the loan’s term.
Open-End Mortgage Example
Assume a borrower secures a $200,000 open-end mortgage loan to buy a home. The loan has a 30-year term and a fixed interest rate of 5.75 percent. They are given the right to the $200,000 principal amount. However, they are not required to take it all at once. The borrower may choose to take $100,000, which would entail making 5.75 percent interest payments on the outstanding sum. The borrower may take another $50,000 five years later. The additional $50,000 is added to the outstanding principal at that time, and they begin paying 5.75 percent interest on the total outstanding debt. Use a mortgage calculator to help you budget for your monthly payment.
In Conclusion,
You are approved for a specified amount with an open-end loan. This is referred to as your credit limit. You do not have to exhaust your credit limit all at once. You use the credit line as needed. When you have paid off that amount, you will be able to re-use the line of credit. The credit line is still “available” for you to use. Credit cards and a home equity line of credit, or HELOC, are examples of open-end loans.
Open End Loan FAQs
What is an open end home loan?
An open-end home loan is one that allows the borrower to increase the amount of mortgage principal owed at a later date. Borrowers with open-end mortgages can return to the lender and borrow more money. The additional amount that can be borrowed normally has a monetary limit.
What are the types of open ended loans?
The types of open-ended loans include:
- Home equity lines of credit, or HELOCs.
- Department store credit cards.
- Service station credit cards.
- Bank-issued credit cards.
- Overdraft protection for checking accounts
