Credit Terms

Credit terms are the payment terms and conditions made by the lending party in exchange for the credit benefit. Examples include credit given by suppliers to buyers of products, and the terms may be 3/15, net 60, which simply means that even though the amount is due in 60 days, the buyer can avail of an additional discount of 3% if they pay within 15 days.

Also known as payment terms, credit terms have evolved dynamically in money markets and are now at a very advanced stage, with every service provider trying to provide more and better services.

Credit terms are the terms and conditions applicable for the sales made on credit. Such terms could be anything from possible discounts or late fines in cases of defaults.

Today, almost every materialistic item can be bought on credit, and there are many easy options to avail of the same. However, we should always keep in mind that the success of this system depends completely on the credit terms set by the service providers and how well they are implemented during the respective term.

Though the terms are strict and difficult to bear, they serve to be useful for buyers as they get enough time to pay back.

There are four factors that help define credit terms in the market.

#1 - Time

The beneficiary is allowed a time benefit (which is why it is not a cash payment), so the transaction can be settled before the actual payment. Typically, the time limits are set before the transaction is made. For example, if the credit terms of 30 days apply for a purchase, the buyers are required to pay the amount within the specified time.

#2 - Amount

The amount to be availed by the beneficiary is limited based on their credibility. The credit-providing party first verifies this credibility based on credit scores, ratings, and other performance-related indicators. The credibility is higher than the credit limit.

#3 - Interest

Based on the type of credit availed, there is a charge against such benefits to the beneficiary. In some cases, like credit cards, there is a one-time fee charged by the credit card provider to the beneficiary party. For post-dated checks, there may not be any such charge imposed on the payer; however, the deal may get only settled after the amount gets settled in the bank. In this case, there is no cash charged; however, the delay in availing services can be considered payment in kind.

#4 - Default Terms

Due to the risk involved in repayments, the credit-providing party always has specific terms related to default. These terms include interest charges, late payment fees, excess payments, or in some cases, termination of a contract.

Besides the above factors, there are other parameters that also help businesses determine credit terms for customers. The first of them is to assess the customers and check how timely they have been in making payments earlier. Plus, it is not necessary to introduce offers for all customers at a time. Businesses can go for one offer at a time based on its merits. For example, introducing credit provisions for new customers or existing customers, etc.

It is recommended that businesses study their competitors to check what credit or payment terms they have to offer to their consumers. This may give one an idea of how to go about it. Apart from these, checking the credibility of customers is mandatory.

Below are credit terms vis-a-vis payment modes.

#1 - Post Dated Check

• The deal may only settle after the transaction settles between the payee and payer banks.

#2 - Credit Cards

• Time benefit of particular days by the respective service provider within the billing cycle.
• No extra charge on the transaction amount if the bill is paid within the due date.
• Amount paid after the due date (and sometimes beyond the agreed-upon grace period), interest shall be levied.
• Credit Card rental, typically on an annual basis, is to be paid as decided between provider and service availing party.

#3 - Secured Loans (Debts)

• Interest is charged to the borrower at a periodic rate and is generally prevalent in the markets.
• In case of default, the borrower is charged with an additional late charge amount on the due amount until paid.
• Collateral is kept as security by the lender until complete repayment by the borrower.

#4 - Unsecured Loans (Debts)

• Unsecured loans have a higher degree of default risk by the borrower. Hence the terms are more stringent than the secured loans, sometimes customized between the lender and the borrower based on the transaction.
• There is no collateral in such loans, so the interest repayment rate is higher than secured loans.
• Default terms are more stringent and sometimes lead to the cancellation of contracts or recovery from the sale of the borrower’s other assets.

#5 - Service-Related Credit Terms

• Credit terms can be created for services imparted as well. For example, a painting company would get only paid after the job is completed, or an employee in a company gets paid only at the end of the month or cycle.
• Most of the time, for any service-related credits, there are contracts made by the provider with the party who avails the service.

Let us consider the following credit terms examples to understand the concept even better:

Example 1

Mr. A takes a car loan of $100,000 from ABC Bank for 5 years, which is to be repaid along with a 10% interest /annum. This interest provision is the fees charged by the bank in exchange for the credit facility they provide.

Example 2

In the above case of Mr. A’s car loan, the bank poses a condition where if Mr. A defaults, interest at the rate of 2% per month shall be charged from the due date until payment of the amount. This, yet again, is another credit term that the payment maker has to keep in mind.

The benefits of such terms include the following:

• The Buyer of Credit is Seller of Risk

The party which avails credit from this service provider transfers its risks to the service provider in exchange for some charges by the provider. Hence it is free from credit risk, which benefits them to make the required transaction in time without delay. But on the other hand, the service provider is said to be the buyer of such risk.

• Fluent Circulation of Money in Markets

With the help of such a credit system in the economy, there is a lesser chance of blockage of money in circulation unless the economy gets into a severe crisis. If the repayment risks are also taken care of, this system leaves very few chances of failure.

• Option to the Cash System

This system acts as an option for the preliminary cash system.

This article has been a guide to what are Credit Terms. Here we explain it with examples, how to determine it, factors, modes of payment, relevance, and uses. We will also discuss the relevance and its uses. You can learn more about it from the following articles –

• Definition of Credit Risk
• Line of Credit
• Letter of Credit Meaning
• Debtor vs. Credit