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Credit

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Credit is a system built on trust between different parties. It allows one person or group to provide money, property, or services to another. The receiver does not pay for these resources immediately. Instead, they create a debt by promising to return the value at a later date. This process makes social reciprocity formal and legally enforceable. It allows large groups of unrelated people to trade and interact safely.

Credit-cards
Credit-cards

There are several distinct types of credit used in the world today. Trade credit occurs in commercial settings when a buyer receives goods but pays later. This is often part of a formal purchase agreement between companies. Consumer credit involves providing money, goods, or services to individuals without immediate payment. This includes common items like credit cards, personal loans, and mortgages. There are also broader categories like investment credit and international credit. Each type serves a different role in how money moves through society.

History shows how credit has evolved from simple ledgers to global systems. In the 19th century, farmers in agrarian communities used credit at general stores. They would buy supplies throughout the year and pay their debts after the harvest. By the 1900s, large companies created credit card chains to simplify payments. These companies charged annual fees to cardholders and percentages to participating businesses. In 1958, banks entered the market with new tools. Bank of America released the Bank Americard, and American Express released its own card. These bank-issued cards expanded purchasing power and introduced revolving credit. Revolving credit allows a person to pay a balance later while paying a finance charge.

While credit helps economies grow, it has not always been applied fairly. In the United States, history shows significant discrimination in how credit was granted. Until the Equal Credit Opportunity Act of 1974, women faced much stricter terms. It was often difficult for a woman to purchase a home without a male co-signer. Additionally, people of color were frequently unable to obtain credit for homes in certain neighborhoods. These laws and social changes have worked to address these historical injustices.

Modern banking is actually a primary engine for credit creation. Many people believe banks only move money between savers and borrowers, but that is not quite right. In the UK, approximately 97% of the money in the economy is created as credit. When a bank issues a loan, it creates a positive asset and a negative liability on its balance sheet. The asset is the expected income from the loan repayment and interest. Most of this newly created credit goes toward purchasing land and property. This activity is a major driver of the economic cycle and can cause inflation.

Banks manage the risk of people not paying them back, which is called credit default. To reduce this risk, they use two main methods: secured and unsecured credit. Unsecured credit, like most credit cards, is not backed by any specific item. Secured credit is collateralized, meaning it is backed by something of value. If a person cannot pay, the bank can take the collateral, such as a house or a car. Common examples of secured credit include consumer mortgages and personal contract plans for automobiles. This protects the bank's ability to recover its funds.

There are also complex ways to manage the risks of credit in global markets. The global credit market is three times the size of the global equity market. One advanced method is the credit default swap market. This is essentially a market for credit insurance. In this system, a protection seller takes on the risk of a default. In return, the buyer pays a premium, often measured in basis points. One basis point is equal to 1/100 of a percent. If a default occurs, the seller makes the buyer whole by covering the loss.

The cost of using credit is more than just the original amount borrowed. Borrowers must pay interest, arrangement fees, and other mandatory charges. To help people compare these costs, many regions use the Annual Percentage Rate, or APR. The APR is calculated based on the pattern of advances and repayments. This promotes "truth in lending" by showing the true cost of a loan. Lenders often determine interest rates using a credit score. This score is based on a person's payment history and prior defaults. A higher score typically grants access to lower APRs.

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