Creditor

Creditor
A creditor is a person or institution that lends money to another. The creditor is then owed that money, usually with interest.

What is a Creditor?

The term ‘creditor’ refers to a person or institution that has loaned money to another person or business.[1] Another term for loaning money is “extending credit”. The person or institution to which the money is lent is the “debtor.”

After credit has been extended to the borrower, the creditor is then owed that money back, typically with interest.

What is interest?

Interest is an amount of money that a lender charges a borrower in exchange for a loan. In other words, inteterest is the cost of borrowing money.[2]

Interest is usually a certain percentage of the principal loan amount that is charged over a specific period of time. For instance, a $1,000 loan with a 10 percent annual interest rate would charge the borrower $100 over the course of one year. Likewise, a $100, 14-day payday loan with a 15 percent interest rate would cost the borrower $15 every two weeks.

What are the different types of Creditors?

A person can become a “personal” creditor by lending money to friends and family. Sometimes, but not always, a personal creditor will not charge interest on the loan and will only ask for repayment of the principal amount. While it is up to every personal creditor whether or not they want to charge interest, it is rarely a good idea to issue a loan without some kind of written agreement between both parties.

Lending money is a business, which is why professional creditors always charge interest. Similarly, creditors always want to be sure that the person or business they are lending to will be able to afford the loan. If the debtor is unable to repay, that means the creditor will lose money. Sometimes, creditors will make the borrower put up a valuable piece of property as collateral in order to secure the loan. Other times, the creditor will only lend to a borrower if they have a good credit score.

Loans that are backed by collateral are referred to as secured loans. Collateral can be any kind of valuable property. If the borrower is unable to repay the loan, the creditor can “repossess” the collateral and then sell it in order to make up their losses. Two of the most common kinds of secured loans are mortgages and auto loans. Mortgages are secured by real estate; auto loans are secured by motor vehicles. Since the collateral protects creditors against potential losses, secured loans usually come with lower interest rates.

Loans that do not involve any kind of collateral are referred to as “unsecured” loans. When there is not collateral to protect creditors against potential losses, these loans oftentimes come with higher interest rates. When deciding whether or not to issue an unsecured loan, lenders will usually check the borrower’s credit score and credit report. This allows them to determine whether or not a potential debtor will be likely to repay the loan they are asking for.

What are credit reports and credit scores?

A person’s credit report is a document that details their history of credit use. Most information on a credit report goes back seven years, but some information, like bankruptcies, can stay on a report for longer. Credit reports are compiled by the three major credit bureaus: Experian, TransUnion and Equifax.[3]

A person’s credit score is based on the information in that person’s credit report. The FICO score, which ranges between 300 and 850, is the most commonly used kind of credit score.[4] The higher a person’s credit score, the more creditworthy they are deemed to be, and the more likely they are to be approved for a loan.

What is the difference between a lender and a Creditor?

People and institutions become creditors by loaning out money to others. In many ways, being a creditor is the same thing as being a lender, though there are some important differences. In order to be a lender, a person or institution must be the one to actually lend out the money. To be a creditor, that person or institution must simply be the entity to which repayment is due. The lender and the creditor are not always the same business.

Sometimes, a lender will make a loan to a person or business and then sell that debt to another institution. That second institution then becomes the creditor, even though they did not issue the original loan. This is often what happens when a person has past due payments on a debt and is sent to collections. Many collections agencies will buy the outstanding debt from the lender—oftentimes for pennies on the dollar. The collections agency then becomes the creditor and attempts to collect as much of the debt from the debtor as they can.[5] In these situations, the lender is often able to simply write off the loss on their taxes.

What kind of businesses are Creditors?

Any kind of business that either lends money or buys debt from a business that does can be a creditor. The most common types of creditors are:

  • Banks
  • Credit Unions
  • Personal Lenders
  • Mortgage Lenders
  • Auto Lenders
  • Payday Lenders
  • Title Lenders
  • Collections Agencies
  • Small Business Lenders
  • Governments

What happens if a debtor cannot repay a Creditor?

When a borrower is unable to meet their obligations on a debt, it is called “defaulting.”  If a borrower defaults on a secured loan, then the creditor has the right to claim ownership of the debtor’s collateral. When a homeowner can no longer afford their mortgage, the creditor who owns their mortgage debt is legally allowed to seize their house. This process is called “foreclosure.” When a person stops making payments on their auto or title loan, the lender or creditor can seize whatever motor vehicle was put up as collateral. That process is called “repossession.”

If a person defaults on an unsecured debt, they will likely be sent to collections. This can either mean that the lender attempts to collect on the debt themselves, or that they have sold the debt to an independent collections agency. Many collections agencies have been known to use aggressive, sometimes-illegal tactics to pressure borrowers to repay. Sometimes, creditors will take borrowers to court and have their future wages garnished until their debt is repaid.

What happens is a debtor cannot repay any of their Creditors?

In cases like this, a borrower has four options:

 

  • They can talk to a credit counselor, who will help them create a budget and form better financial habits. If those steps are not enough, the counselor can set up the debtor with a Debt Management Plan (DMP). Under a DMP, the counselor negotiates with their client’s creditors in order to secure more favorable terms, such a lower interest rates or monthly payments. Credit counselors will not negotiate a reduction in the total amount owed. The debtor issues funds directly to the credit counselor, who then makes payments to the assorted creditors. DMPs often last for years at a time, and debtors are prohibited from taking out any new forms of credit while the plan is in effect. Credit counseling agencies are non-profits, some of which offer their services for free.[6]

 

 

 

  • They can hire a debt settlement company. These are for-profit companies that negotiate with creditors to lower the total amount a debtor owes. These companies charge debtors a fee in return for settling their debts, and, unlike credit counselors, they do not have pre-existing relationships with creditors. This is a high-risk option, as there are many debt settlement companies who will take advantage of their clients.[7]

 

 

 

  • They can negotiate directly with their creditors. One of the reasons that working with a debt settlement company aren’t always the best option is that most creditors have a pre-set amount that they will settle outstanding debts for. Instead of paying to hire a debt settlement company, any debtor can simply work directly with their creditors to settle their outstanding debt. However, no matter who does the negotiating, creditors are not obligated under normal circumstances to accept any amount less than what they are legally owed.

 

 

  • They can file for bankruptcy. There are different kinds—or “chapters”—of bankruptcy, but they all involve a debtor gaining relief from their debts and creditors receiving some kind of repayment. Through bankruptcy proceedings, a debtor could be forced to sell off some of their property in order to pay off their creditors. Likewise, a creditor could be forced to accept a lower amount of money than they were originally owed, or to give a debtor more favorable terms on their debt. While bankruptcy can definitely help someone get out of debt, it will also have a very negative affect on their credit score and their ability to borrow in the future. As such, it’s best used as an option of last resort.[8]

 

 

References

  1. Creditor. Investopedia. Retrieved from http://www.investopedia.com/terms/c/creditor.asp.
  2. Interest Rate. Investopedia. Retrieved from http://www.investopedia.com/terms/i/interestrate.asp.
  3. Credit Reports and Credit Scores. Consumer’s Guide. Board of Governors of the Federal Reserve System. Retrieved from https://www.federalreserve.gov/creditreports/pdf/credit_reports_scores_2.pdf.
  4. What is a FICO Score? MyFICO.com. Retrieved from http://www.myfico.com/CreditEducation/Articles/.
  5. Fontinelle, A. “How the Debt Collection Agency Business Works.” Investopedia. (2014, December 15). Retrieved from http://www.investopedia.com/articles/personal-finance/121514/how-debt-collection-agency-business-works.asp.
  6. “Choosing a Credit Counselor.” Federal Trade Commission: Consumer Information. Retrieved from https://www.consumer.ftc.gov/articles/0153-choosing-credit-counselor.
  7. Debt Settlement Information. American Consumer Credit Counseling. Retrieved from http://www.consumercredit.com/counselingdocuments/debt_settlement.pdf.
  8. Bankruptcy. Investopedia. Retrieved from http://www.investopedia.com/terms/b/bankruptcy.asp.