Understanding Debt

Understanding Debt: A Guide

Debt can put a complicated and uncomfortable burden on many families and households throughout the United States. This article shall cover the different types of personal debt and repayment approaches, so you understand debt and can be put in a better position to deal with any debt issues you might face.

Why Understanding Debt is Vital – How it Can Go Wrong

It’s common to have debt, but understanding debt is very important to prevent bigger issues from occurring. If you don’t understand your borrowing contract’s exact terms, you can accidentally miss a clause and have to pay substantially more money than you can afford to pay. When this happens, you can find yourself in a debt spiral – having to take out more and more loans to cover an unexpectedly large amount of debt that was too much to handle. 

Some of the main problems that debt spirals can cause include selling your home, having possessions repossessed and even having to deal with a lawsuit. Debt lawsuits can be extremely stressful and bad for your health, something that nobody needs, especially as 2/3rds of severe cash problems are related to medical issues and over a third of Americans are struggling with medical debt. Having to deal with a medical debt lawsuit can majorly exacerbate the health problems that cost so much, to begin with. 

There’s also the impact on your credit score. Debt is one of the biggest factors that impact credit scores and the level of debt equate to 30% of the credit score. When you are being scored, credit scorers consider credit utilization, which is the ratio between credit card balance and credit limit across all cards over time. 

The Main Types of Debt

There are two main types of personal debt:

You can have secured debt. This involves offering collateral for the loan, which could be a house, car or other assets. These loans tend to give you better value than unsecured loans as the loaners feel safer with their investment. 

Unsecured debt is the opposite – it doesn’t require collateral so the only way that those offering the loans can make an informed decision about whether they should even offer the loan and if they do, which terms they should offer to protect their money. If you are offered unsecured debt with no credit check, be aware that you will probably be offered a bad deal with bad terms. 

There are many other debt instruments, but they are available for companies; it’s rare for an individual to undertake any debt that isn’t one of these two. 

Understanding Secured Debt

Secured debt is called secured because it’s more secure for those who are loaning the money. The reason it’s more secure is that you put up assets for collateral. These debts can be dangerous as if you don’t understand the terms, you can accidentally promise to give your house or car over to those operating the debt. When you’re putting any asset up for collateral, it’s important to read the terms thoroughly before. Because of this security, however, you get better interest rates. 

The most common forms of secured loans are mortgages and car loans. Secured loans tend to have longer terms (as seen in the average mortgage). These secured loans may even be tax-deductible, like mortgages. 

Understanding Unsecured Debt

Unsecured loans are very common and can vary, ranging from student loans to credit cards to bank overdrafts to medical bills and then to personal loans (including payday loans). These loans differ from secured loans as there is no collateral, so they’re more suitable for those who haven’t managed to get onto the property ladder yet, but they include a check of a credit score and income as well as other details that are at the discretion of the lender. 

Student loans are unique as money is owed to the government, and the loan is typically offered at a low and fixed interest rate.

Repayment Strategies

There are also two main types of repayment strategies on offer to those who have undertaken personal debt.

You can get what’s called a revolving repayment plan, which gives you a maximum limit for you to borrow and repay. This can be done over and over again and is how credit cards tend to work. 

You can also get instalment debt, which involves getting the money up-front and paying it off over time. Normally these payments are monthly (paid in instalments), but most people think of these when they are taking out a loan.  A balloon repayment is a subsection of instalment debt – balloon repayments aren’t paid off until the term in the contract is finished (so that the loaner makes sure they get their profits). 

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