What is a Creditor?

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Definition:

A creditor is a person or financial institution that extends credit or lends money to another party, who then owes the creditor money.

🤔 Understanding creditors

In most cases, a creditor is a financial institution that gives money to customers in the form of loans and credit cards with the expectation that the borrower will pay back the amount. A creditor could also be an individual who lends money to a friend or family member. The person borrowing the money or taking out the credit is known as the debtor. Creditors often make money by charging interest to the person or organization borrowing the money. There are different types of creditors that vary based on the type of credit they issue. For example, some creditors issue loans secured with collateral (meaning an asset they can seize if the borrower doesn’t pay back the debt), while others, such as credit card companies, issue unsecured debt. Governments and other entities can also be creditors.

Example

Suppose you were planning to buy a new car and couldn’t fund the purchase yourself. Instead, you might look for a financial institution to give you a loan. The financial institution is the creditor, while you are the debtor. The creditor might agree to give you the money if you agree to pay it back in a specified number of years. You’ll also have to pay interest, which is the extra percentage you pay to the bank for letting you borrow the money. In the case of a car loan, your vehicle acts as collateral. The bank hangs onto the title of the car, and if you stop making your payments, the bank will take the car.

Takeaway

Borrowing money from a creditor is like your mom lending you her car if you promise to return it the next day with a full gas tank…

Suppose you’re going to a party with some of your friends and you ask your mom if you can take the car. She agrees, but only if you promise to fill the gas tank before you bring it home. In this scenario, your mom is the creditor, as she’s the one lending you something. The car is the loan, and the full tank of gas you have to pay for is the interest you have to pay to take out the loan.

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What is a creditor?

A creditor is an individual, financial institution, or other entity that is owed money as a result of a loan, line of credit, or service the creditor has provided. Creditors are often financial institutions that lend money to customers or extend lines of credit in the form of credit cards and home equity lines of credit.

Realistically, anyone can be a creditor. While creditors are often banks, a creditor could also be a person who lends money to a family member or friend who needs money. Creditors lend money to debtors, which are the individuals or organizations that borrow the money.

What are the types of creditors?

Creditors are individuals or entities that extend loans or credit to another party, but there are different types of creditors depending on who is doing the lending and what type of credit the lender is extending.

  • A personal creditor is someone who lends money to a friend or family member.
  • A real creditor is an institution like a credit union or bank that lends money or extends credit to customers.
  • A secured creditor is one that lends money or extends credit only on secured debt. This type of debt is secured by collateral, meaning the borrower puts up an asset that the lender can seize if the borrower defaults on the debt. Examples of secured debt include car loans, mortgage loans, and home equity lines of credit. Secured debt often has a lower interest rate because the collateral acts as an insurance policy for the creditor.
  • An unsecured creditor is one that lends money without requiring collateral. Credit cards are an example of unsecured debt. There’s no particular asset tied to the debt that the credit card company can seize if you stop paying your bill. Unsecured debt tends to be higher-risk for the creditor, and therefore they often comes with a higher interest rate.

Who are the creditors of a corporation?

It’s not just consumers that borrow money from creditors — Corporations often have creditors, too. Some of a corporation’s creditors might look very similar to those of a consumer. For example, just like you take out a mortgage from a bank to buy a house, a corporation might take out a loan from a bank to buy a building. And just like you might have a credit card, a corporation might have a corporate credit card or credit line to use for business expenses.

Corporations have other types of creditors as well, which can be classified as either senior creditors or subordinate creditors. Suppose a corporation issues bonds to raise capital for an upcoming project. Bonds are an example of senior debt, meaning if the company were to go bankrupt, it would have to pay back the bondholders before paying back some other debts.

Another type of creditor for a corporation is a subordinate creditor. These creditors don’t have first dibs on recouping their losses if a company goes under. One example of a subordinate creditor is a company shareholder. If the company goes bankrupt, the shareholders won’t get their money back unless the company first pays back the bondholders and bank lenders.

Is a creditor a lender?

A creditor is an individual or institution that is owed money. In many cases, a creditor is a lender that gives money to another party for a set amount of time. If you take out a loan from your bank to buy a car or a house, the creditor is a lender. This type of debt is known as closed-end credit.

A creditor could also be a company extending a line of credit. Rather than giving a loan that you have to pay back in a particular period, some creditors extend credit that the consumer has the option of using on a rolling basis. Think of the example of a credit card with a credit limit of $5,000. Your credit card company makes $5,000 available to you to use if you want. You don’t have to use it all or pay it all back by a particular date — Instead, you can use what you wish of the funds over and over again as long as pay it back regularly. This type of credit is known as open-end credit.

Finally, a creditor could be someone who has provided a good or service to you, and you owe them a debt in return. Consider the example of the utility bill you receive every month. Your utility company is allowing you to use its electricity upfront, and then you pay them back later. If you fail to pay the company back, then you’re in debt, making the utility company a creditor.

What is the difference between a debtor and creditor?

While a creditor is one who is owed money as a result of a loan or line of credit he or she has extended to another party, the debtor is the one who actually owes the money. A creditor and a debtor enter into a contractual agreement together. The creditor (aka the lender) lends money or issues credit to the debtor (aka borrower). The debtor then has a contractual obligation to pay back the debt, often with interest.

If the borrower fails to pay back the debt, the creditor might have legal recourse and the ability to take the debtor to court. In the case of secured debt, the creditor can recoup its losses by seizing the collateral the debtor put up for the loan.

For example, suppose you take out a loan from your local bank to buy a new car. Unfortunately, you lose your job a few months later and can’t make your car payments any longer. Because the car serves as collateral on the auto loan, the bank takes your car to cover the loss it took on the loan.

What are some examples of debts?

There are plenty of different types of debts that someone might owe to a creditor. Here are some of the most common:

  • Secured bank loans, which consumers often borrow to pay for the purchase of a new vehicle or real estate
  • Unsecured personal loans, which people often borrow to consolidate debt or fund a large purchase such as a wedding or vacation
  • Credit cards, which are a line of credit that credit card companies extend to consumers
  • Student loan debt, which is a type of loan that many students borrow from the federal government or a private lender to help pay the cost of college
  • Tax debt, which you might owe to the Internal Revenue Service (IRS) if you fail to pay your full income tax bill

How do creditors make money?

Just like any other business, creditors have to make a profit in order to stay in business. They have to find ways to make money from the loans and credit that they extend to customers.

One of the primary ways that creditors make money is through interest payments. When you borrow money, your loan or credit card contract includes a particular percentage of interest. Suppose you have a credit card with an interest rate of 20%. Usually, you won’t pay interest on your balance if you pay it off each month, but many people aren’t able to do that. Instead, the credit card company charges interest on the balances people carry on their cards.

Creditors can make money in other ways as well, including the fees they charge to customers when they borrow money or the late payment fees they charge when customers don’t pay their bills on time.

Finally, your lender might make money if your loan includes a prepayment penalty. Some creditors require that you pay your loan off on a predetermined schedule. If you pay it off faster, they might charge you a fee. This type of penalty is most common on a mortgage loan.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

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© 2022 Robinhood. All rights reserved.