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Decoding Common Types of Debt
Debt comes in different forms.
Debt is a common part of life for many Americans. Some debts may appear more positive because they help propel you towards life goals, like getting a college education or buying a dream home. Other debts, especially those with high interest, tend to get a bad rap for weighing down your finances.
Each type of debt works in different ways, so understanding the different types may help you determine which, if any, is right for you.
Key Takeaways
Different debt types may help you accomplish different financial goals.
Debts may have fixed rates or variable rates, and it’s important to understand how each could impact your budget before you apply.
Debts aren’t inherently bad. Instead, they may be useful tools to help you make large purchases as long as you’re only borrowing what you’re able to repay.
Debt Overview
Simply put, debt is a financial tool. Some of the common forms of debt are mortgages, student loans, personal loans, and credit cards.
When you borrow money, the lender charges interest expressed as an Annual Percentage Rate (APR). APR is expressed as a percent and represents the percentage of the principal debt you pay each year in interest, accounting for monthly payments and fees.1
APRs vary from lender to lender, which is why it’s a good idea to shop around before committing to a loan or line of credit. The higher your APR is, the more you may end up paying the lender in interest.
Repaying debt responsibly is a key factor in building and maintaining good credit, so it’s important to understand the payments in advance and make sure they don’t place a strain on your budget.
Different Debt Types
All types of debt technically involve borrowing funds that are paid back, with interest. But there is a lot of vocabulary used to describe debt types. Here are some of the main descriptors you will find as you do your own research.
Collateral
One term you often hear when researching lending options is collateral. Collateral refers to an asset, such as a vehicle or house, used to secure a debt. Some loans require collateral, some do not; we’ll explore both in a moment.
Secured Debts
Secured debts are backed by collateral or a physical asset. This asset secures the loan, meaning the lender could repossess the asset if you fail to repay them.
Mortgages, car loans, RV loans, and other similar products are all examples of secured debts. Larger purchases like these usually require secured lending in order to offset the risk to the creditor.
The security of collateral may also allow lenders to offer lower rates than what you’d find with an unsecured debt.2
Unsecured Debts
Unsecured debts aren’t backed by collateral. These include student loans, personal loans, and most credit cards. Unsecured debts may be used as a tool to further your education or handle an unexpected expense that you otherwise wouldn’t be able to cover.
Lenders typically have stricter qualification requirements for these loans since they don’t have collateral to settle the debt if you fail to repay. And rates may be higher than what you’d find with secured debts.3
Accessing Funds
Debts, by definition, provide funds that you must pay back. But different debt types let you receive and repay the money differently. Let’s take a look.
Installment Debts
Installment debts allow you to borrow money from a lender and receive that money in a single lump sum payment upfront. You then repay the loan in installments, usually in the form of monthly payments.
These loans may be secured or unsecured. Because these debts have a specified term, you have predictable payments for the length of the debt, unless they have a variable rate.4
Revolving Debts
Revolving debts, like credit cards and home equity lines of credit (HELOCs), work differently. They allow you to borrow money continually rather than giving you a single lump sum payment. Most revolving debts have a set limit you may borrow against and require you to make minimum payments until you pay off the balance.5
It’s most common to have a variable APR when you have a revolving debt.
Rate
It’s hard to imagine borrowing without considering rates. Let’s review the common rate types – fixed and variable.
Fixed-Rate Debts
Fixed-rate debts have an APR that doesn’t change. Many mortgages, personal loans, auto loans, and some student loans are examples of fixed-rate debts.6
With a fixed-rate debt, the loan amount is usually fixed too. This allows payments to be predictable each month—a feature that appeals to some people because it helps them stick to a budget more easily.
Variable-Rate Debts
Variable-rate debts are ones with APRs that change with the market. When market rates go up, the rate you pay on your variable-rate debts may go up as well. When market rates decrease, the rate you’re paying on your debt may also decrease.
When you borrow at a variable rate, you likely have a revolving debt. Make sure you’re prepared for the fluctuation in monthly payments… they could be rough to budget for.
Other Debts
This is by no means an exhaustive list, and you may encounter other types of debts in your financial journey. This may include debts like medical bills, late taxes, and buy now, pay later programs. These debts typically have different repayment terms and varying rates.
How Debt May Impact Your Finances
Taking on debt could help you achieve your financial goals, but too much debt could weigh you down in excess interest and years of repayment. So, it’s important to only take on debt you’re able to repay and to make your payments on time each month, regardless of the debt type you have.
If you miss payments or default on a loan, your credit score could take a hit. And the lower your score is, the harder it could be to qualify for new debts in the future.
Final Thoughts
When taking on debt, be sure to explore your options to understand which type may work best for your situation. And, of course, always shop for the best rate. Consider what you’re able to afford, and what you feel you could reasonably pay… too much debt may set your budget and your credit back.
But debt could also help you to get an education, buy a home, or finance assets that help make your life richer. Therefore, when used responsibly, and strategically, debt is an important tool in your financial wellness journey.