What Is a Creditor, and What Happens If Creditors Aren't Repaid?

What Is a Creditor?

A creditor is an individual or institution that extends credit to another party to borrow money usually by a loan agreement or contract. Creditors are commonly classified as personal or real.

Those who loan money to friends or family or a business that provides immediate supplies or services to a company or individual but allows for a delay in payment may be considered personal creditors.

Real creditors are banks or finance companies that have legal contracts and loan agreements with the borrower that grant the lender the right to claim any of the debtor's real assets or collateral if the loan is unpaid.

Understanding Creditors

Creditors often charge interest on the loans they offer their clients, such as a 5% interest rate on a $5,000 loan. The interest represents the borrower's cost of the loan and the creditor's degree of risk that the borrower may not repay the loan.

To mitigate risk, most creditors tie interest rates or fees to the borrower's creditworthiness and past credit history. Borrowers with good credit scores are considered low-risk to creditors, and these borrowers often garner low-interest rates.

In contrast, borrowers with low credit scores are riskier for creditors and are often charged higher interest rates to address that risk. 

What Happens If Creditors Are Not Repaid?

Secured creditors, often a bank or mortgage company, have a legal right to reclaim the property, such as a car or home, used as collateral for a loan, often through a lien or repossession.

An unsecured creditor, such as a credit card company, is a creditor where the borrower has not agreed to give the creditor any property such as a car or home as collateral to secure a debt. These creditors may sue these debtors in court over unpaid unsecured debts and courts may order the debtor to pay, garnish wages, issue a bank levy, or take other actions.

Creditors and Bankruptcy

Bankruptcy is a legal process through which individuals who cannot repay debts to creditors may seek relief from some or all of their debts. Bankruptcy is initiated by the debtor and is imposed by a court order. 

When a debtor declares bankruptcy, the court notifies the creditor of the proceedings. In some bankruptcy cases, all of the debtor's non-essential assets are sold to repay debts, and the bankruptcy trustee repays the debts in order of their priority.

Tax debts and child support typically rank highest along with criminal fines, and overpayments of federal benefits for repayment. Unsecured loans such as credit cards are prioritized last, giving those creditors the smallest chance of recouping funds from debtors during bankruptcy proceedings.

Original Creditor vs. Debt Collector

While creditors lend money and are owed that money, a debt collector does not lend money. A creditor is the original lender because they made the loan to you. Debt collectors purchase delinquent loans from the original creditor, such as a bank, usually at a discount, and aim to then collect on that loan.

For example, John may owe Bank ABC $10,000 dollars but has not been able to pay it back. His loan goes into default. Rather than continuously attempting to collect on this loan, Bank ABC sells the loan to Debt Collector XYZ for $6,000. This way the bank has recouped some of its losses and can focus on its core business of lending, not chasing down delinquent loans. Debt Collector XYZ then seeks to collect the entire $10,000 from John, which it is legally allowed to do.

The Bottom Line

A creditor is an individual or institution that extends credit to another party to borrow money usually by a loan agreement or contract. On secured loans, creditors can repossess collateral like homes or cars and creditors can sue debtors for repayment of unsecured loans. The Fair Debt Collection Practices Act (FDCPA) established ethical guidelines for the collection of consumer debts by creditors.