Most people will experience some form of debt over the course of their lives. Understanding the different types of debts and how they work is critical to your financial health. The most common types of debt include secured and unsecured debt, revolving debt, and mortgages.
Debt can be useful, helping you to finance a home remodel, a house, a car, education, the list goes on.
Loans and debt can help you cover the costs of big purchases over a longer period of time. In addition, paying back your debts on time will help you build a strong credit history on your credit report, helping you to build a good credit score.
Debt covers anything you borrow money for, including auto loans, credit cards, student loans, medical bills, personal loans and more. Some types of debt are considered better than others. Keep in mind, sometimes only secured and unsecured debt are referred to as the two main types of debt, but there are a couple other types you must know about. The most common types of debt fall under four main categories: secured debt, unsecured debt, revolving debt and mortgages.
Each type of debt has a different set of terms, from the amount of time for you to pay off the debt, the amount of money you are allowed to borrow, the total cost after interest payments and what can happen if you default on payments.
Secured Debt, Unsecured Debt and Revolving Debt
Unsecured and secured debt are typically considered to be the two main debt categories. Revolving debt is a little bit different, but another form of debt that should be understood if you plan to open a credit card.
Secured Debt
Secured debts require the use of collateral when you take out the loan. Collateral refers to any physical asset that the lender accepts as security for the loan. It is a form of protection for the lending company, meaning that if the borrower defaults on the loan, the lender has the right to seize the asset offered as collateral. Collateral is typically a form of real estate, a car or anything else of high monetary value.
Because of the use of collateral, interest rates on these loans are often lower but have a much higher risk to the borrower. Mortgages and car loans are some of the most common types of secured debts.
Unsecured Debt
Unsecured debts do not involve the use of collateral. To cover the costs of the loan and the cost if you fail to repay the lender, interest rates are applied that are often much higher to cover any risk to the lender. When you fail to make payments on time for an unsecured loan, additional fees and higher interest rates are charged.
In addition, interest rates, or annual percentage rates (APR), are dependent on your credit history. If you have a less-than-perfect credit history, you may be subject to higher interest rates and less favorable loan terms.
Revolving Debt
Revolving debt is a little bit harder to explain and is an agreement that allows the borrower to use an amount of money up to a maximum number on a routine, or recurring, basis. The most recognizable form of revolving debt is credit card debts, as they have a credit limit and allow you to borrow up to a certain amount on whatever the consumer wishes. In addition, these loans usually set a minimum payment you must reach each month.
Revolving debt can be continuously reused for the entire amount of time the loan is considered open, as long as you do not reach the limit and pay down the debt over time. Lines of credit are another common form of revolving debt.
Student Loans
When it comes to debt, student loans are typically the first type of debt people encounter. Student loans, either private or government-backed, help you to finance your schooling. They can be used to cover tuition fees and living expenses.
In addition, student loans are only repaid after you graduate, with a fixed monthly payment based on your yearly earnings. In addition, the interest paid on student loans is often tax-deductible.
Credit Cards
Credit cards are probably the most common type of unsecured debt and are also the most common example of revolving debt. Credit cards have a credit limit that is dependent on your credit score, income, and more.
Understanding how credit card repayment works is one of the most important ways to keep your finances healthy. Credit cards only charge interest when you carry a balance from month to month. Meaning, if you pay off your credit card bill in full each month, you will never be charged interest. This is the best way to manage your credit cards, as they come with high-interest rates that can lead to high amounts of debt quickly.
In addition, many credit cards offer additional incentives and rewards such as cash back or travel points. They are also a great way to build your credit score.
Mortgages
A mortgage is not only one of the most common debts people have, but it is also often the largest. These loans are a type of secured loan that is used to purchase a home, with the property available as collateral. Your mortgage has one of the lowest interest rates of any loan product, with additional tax deductions for those interest payments. These loans are loan terms, often for 15-to-30 years to make the monthly payments affordable for the average person.
Personal Loans
Personal loans can be taken out for almost anything: debt consolidation, education, home improvement, etc. Unlike credit cards, they have a set time frame, with a fixed amount of money. Because of this, they often will have lower interest rates than a credit card and have a fixed monthly payment. Like all debts, paying down these debts quickly will often save you money, however, some lenders will charge a fee for paying back the debt early.
In Summary
All debts fall under two main categories: secured and unsecured debt. Understanding each type of debt can help you know when to borrow and when to walk away. For those who made credit mistakes – there’s help: Cambio can help you repair your credit at the lowest costs available online.
