The roles creditors play in the financial market is essential. Besides that, on the individual level, creditors give loans to borrowers to meet their financial needs. These types of loans could be; guarantor, travel, emergency, quick loan, etc.
Creditors have become a good option for financial help for individuals and businesses. This is because you might not always have enough cash flow to carry out your financial obligations. The meaning of a creditor, classifications, and so on are all-inclusive in this article.
Who is a creditor?
A creditor is a person or an institution that extends credit to individuals or businesses. Especially by giving individuals or businesses permission to borrow money they will repay in the future. They also consider businesses that supply goods or services and expect later payment as creditors. This is because the client owes the business money for services they have already rendered.
In accounting, they are used to describing a person, organisation or a government body that is owed money. Typically, because they have provided goods or services to people or businesses. Normally these organisations or people could charge interest in money they lend to borrowers as a way of making money. And they usually see them as interest on bank loan repayments or credit card payments.
What are the classifications of creditors?
There are classifications of creditors:
- Personal Creditors
They are people or individuals who grant loans to friends or family.
- Real Creditors
They have legal contracts with the borrower. This contract sometimes grants the lender (creditor) the right to claim any of the debtor’s real assets (cars, home etc). Especially if they cannot repay the loan. Examples of real creditors are; banks or other finance companies.
Note: Real creditors are financial institutions. In most cases, they also see them as secured creditors.
- Unsecured creditors
Unsecured creditors give loans that are not secured to borrowers. Meaning that they wouldn’t require any collateral from you when you borrow money. An example is a credit card issuer, which could be a bank.
How do they operate?
Having understood the meaning of creditors, it’s also cool to know how they operate.
The interest they charge on loans they offer their clients is their source of income. For example: if a bank lends an individual GH₵10,000 with a 10% interest rate. The bank will then make a profit from the interest on the loan. This is because the bank (creditor) accepts the risk that the borrower may not repay the loan.
Therefore, in order to lessen this risk. Most creditors will sort their interest rates or fees based on the creditworthiness and past credit history of the borrower. So, being a responsible borrower with an excellent credit history could save you a lot of money. Especially if you are taking out a large loan, like a mortgage loan.
For mortgage loans, their interest rates vary based on some factors such as size of the down payment and the lender itself. However, your creditworthiness surely has a primary impact on the interest rate you’ll get.
They consider borrowers with excellent credit scores as low-risk. And because of this, such borrowers get low interest rates on their loans. Whereas borrowers with bad credit scores are riskier for them. Consequently, creditors charge them higher interest rates to address that risk.
What happens if borrowers cannot repay them?
You might want to know what could become of credits who do not receive repayment. If that is the case, they have a few different options to explore.
First, personal creditors who cannot recoup debts from borrowers can claim it as a short-term capital gains loss on their income tax return. In order to do so, they must attempt to reclaim their debts.
Secondly, real creditors (financial institutions) such as banks can repossess collateral such as homes and cars on secured loans. However, with unsecured debts, they can take debtors to court. Where courts would order the debtor to pay, garnish wages, or take other actions in order to compensate the creditors.
How do creditors cope with bankruptcy?
Bankruptcy is a legal process which gives people who cannot repay their debts to creditors the option to seek relief debts they owe.
Where a debtor declares bankruptcy, the court will notify the creditor in that regard. However, in some bankruptcy cases, they will sell all the debtor’s non-essential assets to repay debts. After that, the bankruptcy trustee will repay the debts in order of their priority.
There are priorities that bankruptcy trustees consider in debt repayment.
Debts that get the highest priority are tax debts along with criminal fines, overpayment of federal benefits. Then a handful of other debts could follow. However, the last of these priorities is unsecured loans such as credit cards. And this gives creditors the smallest chance of recouping funds from debtors during bankruptcy proceedings.
Creditors must follow-up on payments their borrowers owe them. This will ensure that they remain stable to offer their services to other borrowers. Besides that, they should check the credit history of borrowers before giving them loans. This is because the knowledge of the credit history of borrowers will help them know who can repay their loans. Therefore, they should get borrowers’ credit history from credit bureaus in Ghana.