Debt: What is it?
What is Debt?
Many people and businesses use debt as a means of making purchases that they would otherwise not be able to afford if they were to pay cash. When debt is taken, the person borrowing enters into an agreement with the lender asserting that the money borrowed will be paid back at a future date, typically with interest.
There are many types of debt out there though in this article we will be dealing with personal types of loans. The most common form of loans for the individual includes mortgages, credit card debt and car loans. Most of these loans typically have terms requiring the borrower to pay back the money owed to the lender by a set date in the future. The borrower is obligated to make agreed-upon payments over several years, in addition to an interest amount as an annual percentage of the loan provided. The lender makes money by charging interest, which covers his risk of lending money while it is in the borrower’s interest to make repayments as soon as he can to reduce the amount of interest payable.
Types of Debt: Good Debt Vs. Bad Debt
While the types of loans out there are virtually unlimited, debts can broadly be classified into either good or bad debt. Good debts are investments which typically generate income over the long term or grow in value. For instance, taking out a loan to pay for University fees is a good debt since it improves your chances of getting a well-paying job and/or getting a promotion. Moreover, these types of loans have comparatively low rates of interest than say credit card debt or even mortgages.
Bad debt is debt taken that does not generate income over the long term or is used to acquire goods that quickly lose value. Most bad debt typically has high-interest rates that take more money out of one’s pocket. A good example of bad debt is credit card debt, which often attracts a very high-interest rate. For instance, charging £200 on your credit card for some fancy shoes can end up costing you up to £250 over several years. By the time you finish paying up, the shoes may be out of style or no longer of value.
How Does Debt Impact People’s Lives
Modern society has become so numbed to the idea of debt that many people never think of how debt can impact their lives in the future. Nonetheless, debt can have either a negative or positive impact on people’s lives.
The Positives and Negatives of Debt
Overall, low-interest debt are generally good debts and can be used to aid you in a positive way. Home equity and student loans fall in this category since they have lower interest rates than credit cards or auto loans. A home equity loan usually has lower rates as the lender takes your home as collateral for the loan. Your interest rates are then determined according to the lender’s appraisal of the home. On the other hand, the student loan is guaranteed by the government.
Taking out a mortgage on a home is, for the most part, good debt and is recommended for anyone that can afford it. Similar to student and home equity loans you will generally pay lower interest rates on mortgages as compared to other loans. l. While a mortgage is a long term loan that can in some instances be spread out over as many as three decades, the low monthly payments mean your budget is not stretched leaving you with enough to pay for emergencies and other investments. Since house prices have historically risen, you could find that you have made a profit once you finish paying off the mortgage.
A car loan can also be seen as good debt, particularly if you took out the loan intending to use the vehicle to conduct business. If you take out a loan on a van to transport goods or even to move from place to place while conducting business, you will save a lot that you would have had to pay for contracting transport. Moreover, once you pay off the loan, most of your expenses will be on fuel and maintenance making it a good deal overall. However, given that vehicles, unlike homes, lose value over time, it is best to pay a huge chunk up front, so that you can get the best value out the car while ensuring you get low-interest monthly payment terms.
The worst kinds of debt typically have high-interest rates and short repayment periods and include the likes of cash advance and payday loans.
With payday loans, the lender requires the borrower to write a personal check for the amount he needs to borrow and the interest for the set period. The borrower has to pay the loan and interest on their next payday. Given that these loans do not have collateral, the interest rates are typically astronomical. Lenders also charge very high fees when one fails to pay the loan, which then has to be rolled over to the next payday.
How Debt is accumulated
Most people that get into debt typically do so because of a combination of impersonal and personal financial factors. Debt accumulates due to personal financials that include keeping up with the Joneses, living beyond your means, and social costs such as weddings and college. Impersonal financials that often result in debt include unplanned medical emergencies, relocations, and unemployment among others. Debt can accumulate as a result of a combination of these factors or the explosion of one of these factors that makes an okay situation turn into a bad one.
How Debt can get out of Control.
Even persons who believe they have their debt in control can find themselves in a dire situation if they do not keep an eye on their debt. The following are some of the ways debt can spiral out of control:
- Not Knowing how much you owe – Many people just do not know how much they owe, their monthly payments, and due dates, which makes it hard to see the big picture and make a good plan for repayment.
- Late Repayment – Late payments lead to a snowballing of debt as lenders pile on late fees and hike interest for late repayments, which become even worse if you miss several payments.
- Not making minimum payments – While minimum payments will not help reduce the debt, at least they stop the snowball. Persons who do not make minimum payments soon find their debts growing exponentially.
- Not having a repayment plan – Not having a repayment plan is one of the biggest reasons for debt running out of control. High-interest payment debts such as credit card debts can grow very fast if their payment is not prioritized.
- Not Paying off charge-offs and collections – Not paying off the accounts in good standing could destroy your credit, resulting in higher interest rates and fees that make it harder to obtain credit, complicating a bad situation.
- Not having an emergency fund – Emergencies do happen and when these happen and one has nothing to fall on, they can go into debt. If it is an expensive emergency such as loss of employment one could even get into bad debt such as cash advances and payday loans.
- Not acknowledging that one needs help – Just like an addict, a person with bad financial habits needs to acknowledge that they have a problem before it can be solved. Persons who do not acknowledge that they spend too much, they do not plan or set aside cash for emergencies are likely to have their debts snowball.
Who to talk to if you are struggling with Debt
If you ever find yourself in debt and are unable to get out, you need to speak to a professional. The right persons to talk to when you are struggling are debt counselors. There are many institutions such as which will provide free counseling to help you get out of debt. These institutions will also help you set up a debt management plan so that you can establish a budget, get your finances in order and finally get out of debt.