A creditor is a person, bank or other company that has granted credit or has loaned money to another party, which it is intended to receive back in the future. The party to whom the credit has been granted is a customer, who will now be referred to as a debtor.
The company that supplies services or products to an individual or a company is also considered a creditor, without demanding payment immediately, due to the fact that the client owes money to the company for the products or services already provided.
Banks and other financial institutions form an important part of the creditors that operate in today’s economy, although through the growth of schemes such as private loans, individuals can also become creditors of companies.
Companies and government agencies make up additional creditors, who can offer financing to growing businesses.
The term creditor is used frequently in the financial world, especially in reference to short-term loans, long-term bonds, and home loans.
Basically, the debtor-creditor relationship is similar to the customer-supplier relationship. You can be a customer and a supplier at the same time, just as you can be a debtor and a creditor at the same time.
Amounts owed to creditors are reported on the company’s balance sheet as liabilities.
Most balance sheets report the amounts owed to creditors in two groups: current liabilities and non-current (or long-term) liabilities.
How Creditors Make Money
Creditors make money by charging interest on the loans they offer to their clients.
For example, if a creditor loans the borrower $ 5,000 at an interest rate of 5%, the lender makes money because of the interest on the loan.
In turn, the creditor accepts a certain risk, which is that the borrower cannot pay the loan. To mitigate this risk, creditors index their interest rates to the creditworthiness and credit history of the borrower.
Mortgage interest rates vary based on a host of factors, including the amount of the advance and the creditor himself. However, creditworthiness has a primary impact on the interest rate.
Borrowers with excellent credit ratings are considered low risk to creditors. As a result, these borrowers get low interest rates.
In contrast, borrowers with low credit scores are riskier for creditors. To cope with risk, creditors charge you higher interest rates.
What to do if a creditor is not paid
If a creditor does not receive repayment of a debt, it has certain resources to collect it.
If the debt is backed by collateral, such as mortgages or car loans, that are backed by houses and cars respectively, the creditor may try to recover this collateral.
In other cases where the debt is unsecured, the creditor may take the debtor to court, with the intention of garnishing the debtor’s wages or ensuring that another type of order of repayment is generated by the court.
Personal creditors who are unable to recover a debt can claim it on their tax return as a short-term capital gain loss. To do so, they must make a significant effort to claim the debt.
Creditors and bankruptcy cases
If a debtor decides to file for bankruptcy, the court notifies the creditor of the process. In some bankruptcy cases, all of the debtor’s nonessential assets are sold to pay off debts. The bankruptcy trustee pays debts in order of priority.
Tax debts and alimony often get top priority, along with criminal penalties, federal benefit overpayments, and a handful of other debts.
Unsecured loans, like credit cards, are prioritized last. This gives creditors the least chance of recovering funds from debtors during bankruptcy proceedings.
In general, creditors can be classified in two ways, as personal or real. People who lend money to your friends or family are personal creditors.
Real creditors, such as banks or finance companies, have legal contracts signed by borrowers. This gives the lender the right to claim any of the debtor’s real assets, such as real estate or cars, if the loan is defaulted.
Creditors can also be divided into two categories: secured and unsecured. A secured party has a collateral or charge, which is part or all of the company’s assets, to secure the debt owed to it.
This could be, for example, a mortgage, where the property represents security. An unsecured creditor does not have a charge on the company’s assets.
Types of debt
The distinction between senior debt and subordinated debt is crucial for creditors and investors.
Senior debt is considered less risky than subordinated debt. This is because it is the first in the payment line, after the means of payment are available.
That means that the interest rate paid on senior debt is lower than that paid on unsecured debt.
Example of a creditor are company employees who are owed wages and bonuses. Also the government to whom taxes are owed, and customers who have made deposits or other advance payments.
Suppose a scenario with a real creditor, bank XYZ, who is approached for a loan. If you approve and loan the money, bank XYZ becomes the creditor.
Individuals and businesses can have multiple creditors at any one time, for many different types of debt.
Additional examples of creditors extending lines of credit for money or services include: utility companies, health clubs, telephone companies, and credit card issuers.
Not all creditors are considered equal. Some creditors are considered superior to others, or senior, while others will be subordinate.
For example, if Company XYZ issues bonds, the bondholders become senior creditors of Company XYZ shareholders. If XYZ Company later goes bankrupt, bondholders have the right to repayment before shareholders.
- Investopedia (2018). Debtor. Taken from: investopedia.com.
- Accounting Coach (2018). What is the distinction between debtor and creditor? Taken from: accountingcoach.com.
- Investopedia (2018). Creditor. Taken from: investopedia.com.
- Accounting Coach (2018). What is a creditor? Taken from: accountingcoach.com.
- Wikipedia, the free encyclopedia (2018). Creditor. Taken from: en.wikipedia.org.
- Investing Answers (2018). Creditor. Taken from: investinganswers.com.