A Comprehensive Guide to Types of Debt
Debt is a necessary element of the American economy. Without financing, most of us wouldn’t own cars, would never become homeowners, and wouldn’t be able to start a business. But, for all the possible benefits of our financial system, Americans without any debt are firmly within the minority.
At the last count, the average American held $34,000 in consumer debt. When you have excessive amounts of debt, you simply cannot build for the future. You’re at the mercy of your creditors.
Part of practicing good financial habits requires understanding the different types of debt and how you should address them. Not all debts are designed to be managed in the same way.
Here’s what you need to know about the different types of debt.
What is Debt?
The concept of debt is a simple one. You borrow money from a lender and pay the money back by an agreed-upon date with interest.
Unfortunately, where most people go wrong on debt is that they miscalculate whether they have the means to pay it back. A lack of financial literacy means a failure to budget and take into account interest rates as well as a misunderstanding of the type of consumer debt. Let’s take a look at the various types of debt:
Secured vs. Unsecured Debt
The two primary forms of debt are secured and unsecured loans.
A secured debt is a debt held against a specific asset. For example, your mortgage is a type of secured debt because the debt is secured against your house. Fail to repay, and your mortgage lender will repossess your home.
Fail to repay an unsecured debt, and the lender may pass your case to collections. What are debt collectors, you ask? These are the agents who will turn up on your doorstep or leave you countless voicemails demanding repayment of the debt, a repayment plan, or physical possessions in lieu of cash.
Collection agencies are paid a fee to collect. Eventually, your debt might be sold to a collector for pennies on the dollar, and you would then owe that company your payment instead.
Revolving vs. Non-revolving Debt
Non-revolving debt is the simplest type of debt, You borrow a specified amount, and you repay it in fixed, monthly installments. Some debt examples of non-revolving debt include car loans, student loans, and mortgages.
Revolving lines of credit can be replenished as you pay back what you borrowed. Credit cards are types of revolving debts because you can instantly borrow more money once you repay the balance owed.
Types of Debt Explained
All major types of debts have different characteristics associated with them. It’s vital to practice smart financial habits by understanding various debts, what they’re used for, and why you may utilize them.
Credit Card Debt
Average Interest Rate: 17%, as of mid-2020.
How It Works: Unsecured loans. Interest rates only kick in at the end of the month. If you pay off the balance by the deadline, it won’t cost you anything.
Why Should You Use It: Excellent option for building up your credit score. Every payment you make improves your score but keeps your use low. Higher credit scores allow you to borrow more at lower interest rates later. Credit cards are also safer for online purchases than debit cards.
Student Loan Debt
Average Interest Rate: 4.5%
How It Works: You borrow for your education, and you pay the money back over your working life. Standard unsecured debt with minimum monthly repayments. It cannot be discharged by bankruptcy.
Why Should You Use It: To put it simply, unless your family is wealthy or you got a full-ride scholarship, student loans are unavoidable. Check if your employer provides tuition reimbursement first.
Average Interest Rate: 10%-28%
How It Works: Standard unsecured loan with monthly repayments. Borrowers with low credit scores can take out secured personal loans.
Why Should You Use It: Ideal option for unexpected emergencies or large home improvement projects. Although, a home equity line of credit or refinancing a mortgage might be better for improvement projects.
Average Interest Rate: 5.27%
How It Works: Secured loan on your vehicle. Monthly repayments are required over an average 60-month term.
Why Should You Use It: Try to avoid it. It makes little sense to make high monthly repayments on an asset that decreases in value over time.
Average Interest Rate: 2.78% on 30-year fixed mortgages.
How It Works: Secured loan against physical property. It translates to “death contract.” Minimum monthly payments required.
Why Should You Use It: The vast majority of people can’t pay cash for a home. However, this is a long-term investment. Often real estate prices outpace inflation, and you could save money compared to renting.
How Debt Affects Your Credit Score
Your credit score is a reflection of how trustworthy you are as a borrower. A long history of repaying debt on time means lenders will reward you with higher limits and lower interest rates.
All debt classes will have a positive impact on your credit score in the long term. This is why it’s so vital to make your minimum monthly repayments on time.
Tips for Getting Out of Debt
- Make a budget. Know what’s coming in and going out every single month. Your budget enables you to make informed financial decisions.
- Pay the types of debt with the highest interest rates first. Interest payments are dead money.
- Consider a type of debt financing if you’re in trouble. Refinancing enables you to get a new debt instrument to pay off the old one. They’re easy to qualify for and often mean lower interest payments over time.
Choose the Collections Bureau of America
Debt is difficult to manage. Whether it’s understanding debt classification or knowing your options, if you’re struggling to collect certain types of debt, contact the Collections Bureau of America to learn more. With more than 50 years in the business, our collection agency approaches each and every client with the care and attention they deserve.