What Are The Different Types Of Debt?
People generally have different types of debt and can be difficult of understand
the complexities of the different types. In order to make an accurate assessment
of your debt and deal with it effectively, you need to look at more than just the
amount of debt you have. It is important to understand the different types of debt
that exist and then categorize them according to your financial situation. The main
types of debt are explained in simple terms...
Secured debt is a term used to describe a debt, such as a mortgage loan, that is
backed by a legal claim against a borrower's asset such as a property. You could
risk losing your home if the debt is not repaid. The lender has the right to sell
the property to recover the money owed.
An unsecured debt is a debt that is not backed by any collateral. These can be typically,
credit card debts, medical bills and payday loans and can also be eliminated in
Instalment debts are debts that are fixed in repayment amount. The interest charge
is fixed up front before you start to pay the loan. An example of this type of debt
is a fixed car repayment loan. This type of debt is useful for budgeting as you
know exactly what is due every month, until the debt is paid off in full.
A revolving debt does not have a fixed repayment and the balance owing may change
from month to month. Repayment is usually a percentage of the outstanding balance
and often paid monthly. The most common revolving debts are credit cards issued
by banks and department stores. Revolving debt is riskier than instalment debt as
you can change the amount borrowed through continued spending.
Personal debt is often referred to as “bad debt”. This results from a purchase of
an asset that will be likely to depreciate in value over time, such as a car. This
kind of debt should be avoided where possible as you are not only giving the lender
interest on your borrowing but the commodity you have bought will not be worth as
much as you paid for it shortly after you have bought it – and will continue to
lose value in time. The worse kind of bad debt is that which offers short term pleasure
such as a holiday or eating out.
Good debt can be categorized as investment debt and is best described as a purchase
of an asset which is likely to appreciate in value over time. The best example of
this is buying a home, as in time, a house will generally increase in value overall.
Also the tax deduction alone on mortgage interest makes investment debt one of the
more acceptable types of debt. Other examples of investment debt are education or
starting a new business.