Credit is a contract in which one party advances value now against a promise of repayment later. Every credit product — from a credit card to a mortgage to a business loan — is a variation on the same three elements: principal, interest, and term. Understanding the contract before signing it is the single most important credit skill.
- 01State the three elements of a credit contract.
- 02Distinguish secured from unsecured credit.
- 03Compute the total cost of a credit product from its APR and term.
Principal, interest, term
Principal is the amount advanced. Interest is the price of the money, quoted as an annual percentage rate. Term is the schedule over which principal and interest are repaid. Every additional feature — introductory rates, fees, penalties, collateral — modifies one of the three.
Secured versus unsecured
Secured credit is backed by collateral — a house for a mortgage, a car for an auto loan, cash for a secured card. Unsecured credit — most credit cards and personal loans — is backed only by the borrower's promise and creditworthiness. Secured credit is cheaper because the lender's downside is smaller.
The number that matters
Total interest paid over the life of the loan. Not the monthly payment. Not the APR alone. Not the discount off list. A $30,000 car loan at 7% for 60 months costs the borrower roughly $5,600 in interest — the number the dealer will never quote.
- Principal, interest, term. Every product is a variation.
- Secured credit is cheaper. Collateral is cheaper than promises.
- Total interest paid is the number that matters.