How Do I Choose the Best Credit Instrument?

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  • Written By: K. Kinsella
  • Edited By: Shereen Skola
  • Last Modified Date: 30 May 2018
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Credit instruments are debt products that consumers and businesses can use as an alternative to cash. Banks and other financial institutions market a number of different credit instruments ranging from fixed loans to credit cards. When choosing the best credit instrument, a borrower should consider the payment, interest rate, collateral requirements and the product's purpose.

Lenders use a calculation known as the Debt-to-Income (DTI) ratio to assess a loan applicant's ability to repay a debt. This involves dividing the borrower's monthly debt payments into the borrower's income. Lenders do not factor costs such as utility bills, school expenses and other ongoing costs into the equation, so the lender may approve a credit instrument application for the borrower even if the borrower feels that the payment is unmanageably large. Borrowers should not take out credit products unless the required payments are affordable. Someone on a tight budget may benefit from taking out a credit instrument with a lengthy repayment term since this product would have lower monthly payments than a product with a short repayment term.


Credit instruments either have fixed or variable rates of interest. In many instances, variable rate debts have rate minimums and caps so the borrower should compare these minimum and maximum rates with the terms available on a fixed rate loan. If the variable rate loan cap barely exceeds the currently available fixed rate then the borrower may benefit from accepting a credit instrument with a variable rate. Conversely, if the variable rate cap greatly exceeds the fixed rate options then the variable rate product may result in sizable monthly payments further down the line. The longer the loan term, the greater the chances are of the rate rising.

Many types of loans, including mortgages and vehicle loans, are secured by some form of collateral. Lenders typically offer lower rates on secured loans than on unsecured loans because collateral loans expose the lender to a lower degree of risk in the event of borrower default. Collateral requirements vary from lender to lender and many lenders refuse to finance certain types of property or vehicles beyond a certain age. Anyone lacking suitable collateral must apply for an unsecured credit instrument such as a personal loan or a credit card. Individuals who own acceptable forms of collateral have many more borrowing options.

Some fixed rate loans have prepayment penalties which means that these debt instruments are not suited to people who plan to repay their debt within a short period of time. Credit cards and revolving credit lines are instruments on which borrowers only have to make small monthly payments. These products usually have variable interest rates which means that a borrower's overall costs can dramatically rise if the borrower proves unable to quickly repay the debt. Therefore, a borrower should obtain a credit instrument that serves their needs at a particular time rather than making a decision based purely on a single factor such as the interest rate of the monthly payment.



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