4.2.1 How credit works

You (the borrower) borrow a sum of money from a lender. You must repay the principal in full, with interest, usually within a specified time frame. Some loan agreements specify equal bi-monthly, monthly or annual payments, while others require a single payment of both principal and interest.

Normally the lender conducts a credit check of your credit history to see if you are a good credit risk—that is, if you are likely to repay the loan in full and on time. If not, the lender may refuse to offer you the credit or you may have to pay a higher rate of interest.

Some loans require nothing more than your promise to pay. Others require you to pledge certain assets as collateral as security for repayment of the loan.

Definitions

• Borrower: Someone who borrows money from a financial institution or other lender
• Lender: A company, financial institution or individual who loans money to a borrower, with certain conditions for repayment
• Principal: The amount of money loaned, without interest added
• Interest: The amount paid by a borrower to a lender for the use of money, usually expressed as a percentage of the total amount of the loan
• Credit check: A review of your financial reputation and credit history
• Credit history: A record of your use of credit, including how much you have borrowed and whether or not you have repaid loans in full and on time
• Credit risk: A lender's risk of loss arising from a borrower who does not make payments as promised
• Collateral: Anything offered as security for the repayment of a loan—if you do not repay, the lender can seize and sell your collateral as compensation.