What is a Creditor

Whether it is a company borrowing a business loan to tide over cash flow issues or an individual applying for a credit card, lending takes place in different forms. And every lending transaction has two key stakeholders -- the creditor and the debtor.

But what are creditors and how to distinguish between creditors vs debtors? Here’s a guide to help you understand:

Typically, the term creditor refers to someone who extends credit or offers a credit line to someone else. This is done with the understanding that the debt owed will be repaid. If the person borrowing such credit doesn’t repay, usually the creditor has a legal right to initiate the recovery of the amount. Here’s an illustration to understand the meaning better:

Suppose you have three credit cards, one home loan, and one car loan. In that case, you have five creditors as you owe a debt each to the credit card issuers and the banks. You have standalone agreements with each creditor, and all of them can sue you individually if you fail to repay the owed amounts.

Those who provide goods to services to another person or company without asking for immediate payment in lieu of their service are also considered creditors. Depending on the circumstances, terms such as lessor, mortgagee, or lender are used interchangeably to refer to a creditor.

But how is extending money on credit beneficial for creditors? Creditors such as banks or financial institutions make a profit off the lending by charging interest. For instance, if A lends $1,000 for two years at an interest rate of 6%, A gets repaid $1,127.49. Apart from that, a creditor may also charge a variety of fees, such as penalties for delayed payments and processing fees.

Since lending comes with a risk of not getting repaid, creditors use credit scores to determine the creditworthiness of the borrower. The creditworthiness also impacts various aspects of the borrowing, such as the interest rate, the amount available to borrow, and other repayment conditions. In parallel, creditors also have an obligation to share information about their borrowers, including their payment track record, with credit reporting agencies to help them prepare credit reports.

Credit unions, financial institutions, and banks are the most common examples of creditors. They are known as also known as loan creditors.

Other entities or individuals who provide services or supply goods without receiving immediate payment also qualify as creditors. They are more commonly known as trade creditors.

Creditors are classified into several categories, such as:

Secured creditor

Such a creditor extends credit only if the debtor can offer an asset as collateral. If the debtor fails to repay as per the credit arrangement, a secured creditor can take possession of the collateral and sell it to recover its debt.

A typical example of a secured creditor are banks providing a car loan or a mortgage loan where the car or the house serves as collateral. If you do not pay the loan instalments as per the agreement, the lender can take possession of your car or house and hold an auction to sell it off and recover the dues.

Unsecured creditor

The opposite of a secured creditor is an unsecured creditor. They do not need collateral from the borrower to extend credit.

For example, a credit card company is an unsecured creditor. Even though you owe the credit card issuer money that you spend on your card, it is an unsecured debt since you do not furnish any asset as security for such debt.

If you fail to repay the borrowed money, unsecured creditors can file for a general claim on your assets to liquidate them, or the court may directly order you to repay.

Real creditor

Creditors such as banks, financial institutions, or credit card issuers, who legally have a right to be repaid, are known as real creditors. Unlike personal creditors, real creditors do not have any personal relationship with the borrower.

The repayment terms are strict, and failure to pay off the debt can have immediate consequences, such as your credit history and your credit score being impacted.

Personal creditor

Sometimes you may borrow money from your family or friends. Such creditors are known as personal creditors.

While they are technically creditors, the relationship is not formal or bound by a legal agreement. In fact, in some cases, the borrowed money may not even be subject to any interest rate. Even if you default in repaying, the risk of facing any legal action is minimal.

Personal creditors can recoup their loss by claiming short-term capital gains when filing their taxes.

To understand the differences, let’s first understand what is a debtor. Any entity that borrows money on credit is known as a debtor. Individuals and businesses can be debtors, regardless of the size of the debt or the type of the creditor they borrow from. In most cases, debtors need to repay the amounts owed along with interest.

Therefore, the critical distinction between creditors and debtors lies in the actions they perform. In other words, those who extend credit to an individual or a business and are owed a debt are creditors. Whereas those who borrow from a creditor and owe them money are debtors.

From a financial accounting perspective, too, there exists a difference between debtors vs creditors. A company’s balance sheet records a debtor as a current asset, whereas a creditor of the company is a current liability.

It is also worth noting that every business is effectively both a debtor and a creditor. Unless the transaction is in all cash, payments to suppliers are made on a deferred basis, making the business a debtor. Similarly, if the business is owed money by its customers, it becomes a creditor.

Customers of a bank or financial institution who have borrowed money, whether through loans or credit cards, are debtors as they owe a debt.

Customers of a business who purchase goods or avail services and can make payments for the same at a later date are also debtors. But if they pay immediately, they are not debtors.

When it comes to financial reporting, creditors of a company are classified as liabilities. The reason is that the company has an obligation to repay the extended credit to its creditor over a period of time.

If a creditor has extended a debt repayable within one year, they are reported as current liabilities. If the debts are payable for more than a year, such creditors are reported as long-term liabilities.

To sum up, creditor meaning is simple -- anyone you owe money to is your creditor and you are their debtor. The relationship between creditor and debtor is such that one cannot exist without another.

Creditors such as banks and financial institutions have strict eligibility criteria for their debtors and closely review the credit score before lending.

Check your credit score for free with ClearScore to know whether you qualify before approaching any creditor.