What is a Creditor?

Key takeaways:

• A creditor is an entity that extends credit, such as a bank or an individual, while a debtor is the entity that borrows money.
• There are two types of creditors: personal and real creditors, and two types of loans: secured and unsecured.
• Creditors charge interest on the money they lend, and borrowers can potentially eliminate their obligations by declaring bankruptcy.

A creditor is any entity that extends credit to an individual, business, or agency. Banks are the most common example of creditors, but individuals and other types of companies can be creditors as well. Another way to say it is a creditor is an entity to which a financial obligation is owed. The entity that borrows money from a creditor is known as a debtor.

For example, if you have a credit card, the financial institution that issued the card is the creditor. If you borrow money from a friend, your friend becomes the creditor. A creditor typically documents the money owed with a loan agreement or some other type of contract.

Creditors typically charge interest on the money they lend to borrowers, although there are exceptions. For example, it’s common to see 0% APR offers on credit cards and some companies provide interest-free financing for customers of certain merchants.

Personal creditor vs. real creditor

The first big distinction to know is the difference between personal creditors and real creditors. A personal creditor is exactly what it sounds like—a person who lends money to a person or business with the expectation of being paid back. If you lend money to a friend or family member, you are a personal creditor.

A real creditor refers to some type of financial institution that lends money to an individual or other entity. Banks are real creditors. One of the most common differences is that real creditors typically use legal agreements and contracts that clearly outline what happens if the borrowed money isn’t repaid as agreed. It’s certainly possible (and a good idea) to have formal loan agreements even when lending to friends and family, but it isn’t common.

Secured creditor vs. unsecured creditor

Another distinction is the concept of secured and unsecured creditors. It’s important to know the difference between these two types of creditors, as these have different ways to attempt to collect the owed money if a borrower stops paying.

Secured creditors loan money that is backed, or secured, by a certain asset. For example, when a mortgage lender extends credit, the loan is backed by the home the borrower uses the money to buy. If the borrower fails to make their payments on the loan, the lender has the ability to foreclose on the home and ultimately sell it to recoup its money. Auto loans are the other major type of secured loan, although there can be others. If a creditor ever asks you to pledge collateral, they’re asking for the ability to take certain property if you don’t pay them back.

On the other hand, an unsecured creditor lends money that isn’t backed by a specific asset. Credit cards are a good example. If you buy a new TV with your credit card and don’t pay the bill, the bank or credit card issuer can’t show up at your house and take it away. Plus, money from unsecured debt can generally be used for whatever goods or services the borrower wants to buy, while secured debt typically has to be used to acquire a certain asset to justify the loan. Companies that originate personal loans also fall into the category of unsecured creditors, as do student loan companies.

However, just because unsecured creditors don’t have a right to repossess specific assets doesn’t mean they can’t do anything if you don’t pay. Both types of creditors will report your late payments to the credit bureaus, and failure to pay unsecured debts can result in collections activity, wage garnishments, or even lawsuits.

Borrowers can potentially eliminate their obligations to creditors by declaring bankruptcy. During bankruptcy proceedings, a debtor’s assets are distributed in a particular order to their creditors, and most debts that cannot be satisfied can be discharged. However, a bankruptcy on a credit history can be devastating to an individual or business’ credit scores and can prevent them from borrowing money for years.

What’s the difference between a creditor and a lender?

The terms creditor and lender are often used interchangeably, but there are a few subtle differences. For example, if you apply for and receive a credit card, the bank that issued the credit card extends credit to you, and therefore becomes a creditor. The bank itself is a lender. In short, the term creditor is typically used to describe the entities that a particular individual or business owes money to. On the other hand, the term lender is often used to simply describe a type of business or individual that loans money.