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What are the different types of debt?

Dena Standley | July 27, 2022

Summary: There are four primary types of debt. This article discusses each one.

Debt comes in many shapes and sizes, and not all are bad. In short, debt is simply borrowing money and repaying it, and loans are classified according to their purpose. Secured, unsecured, revolving, and installment debt are the most common. Some of these overlaps, as you'll see below.

A CNBC report in 2021 shows the average American owes $90,460 in debt, including credit cards, personal loans, mortgages, and student loans. Any debt holds you back, no matter how small or how large! To help you navigate the vast world of debt, let's walk through the different types of debt and why some types are riskier than others.

There are four primary types of debt, and we will discuss each of them in this article. They are:

  1. Secured debt
  2. Unsecured debt
  3. Revolving debt
  4. Mortgages

Secured debt is riskier for you

Secured debt involves borrowing money backed by a physical asset, and the asset acts as collateral. Before lending you anything—money for a car, boat, RV, or even a home—a bank or other lending institution reviews your credit history, which influences your interest rate (the amount charged for borrowing the money).

The lender puts a lien on your property (also known as a claim of ownership), and they can repossess or foreclose on your possessions if you stop making payments. Lenders benefit from secured debt because it means less risk for them. They either get their money back, or they resell the item. It's riskier for you, though.

You'll be saying goodbye to your Honda if you can't pay off the loan on which you used it as collateral. With assets that depreciate over time, vehicles, you may end up underwater and owing more than the purchase is worth.

Unsecured debt comes with high-interest rates

When money is borrowed with no collateral, it's known as unsecured debt. Examples include:

  • Credits cards
  • Payday loans
  • Personal loans
  • Student loans
  • Medical bills

Unsecured debt has higher interest rates because it means more risk for the lender if you don't pay up. It also means you are more likely to face lawsuits or debt collectors if you miss a payment.

When you're not careful, unsecured debt can pile up fast. With secured loans, there is the possibility of losing your car, home, or something you use daily. This motivates you to pay. Unsecured debt may require more self-discipline and budgeting, as failure to pay it back doesn't have such immediate effects.

The cycle of revolving debt

The term 'revolving debt' refers to an open line of credit—a potentially vicious cycle of borrowing money and paying it back, just to borrow more. If you pay the minimum amount before a specific date each month, you can borrow up to a certain amount (called a credit limit). Examples of revolving debt include:

  • Your credit card
  • Store cards
  • Lines of credit at businesses

When you have this type of debt, it's easy to feel like your credit is in control since the minimum payments you make are usually much smaller than your credit limit. Pay interest in the remaining amount if you pay the minimum due each month (or anything less than the total balance).

A missed payment will cause a late fee, and many types of revolving credits include a clause allowing interest rates to skyrocket after a missed payment. That being said, revolving debt doesn't have to be bad. Many consumers use credit cards responsibly, taking advantage of various rewards and paying their balance off in full each month. If you have an established history of treating your debt responsibly, then revolving debt may be safe for you.

However, things happen, and even those with stellar payment histories can find themselves facing a sudden change in life's circumstances. It only takes one missed payment to tank a healthy credit score, making it difficult to regain your financial footing.

Non-revolving debt, you get it once

Non-revolving debt cannot be used repeatedly. Whether it's a mortgage, a student loan, a business loan, or a car loan, it's an important financial decision. In this situation, you borrow a specific amount of money that you must pay back in installments before a particular date. Your minimum payment is usually determined by how much you initially borrowed each month. The funds you have spent on a loan are gone once you pay it off.

Interest is part of this type of debt, but the interest rate is usually lower than revolving debt interests because the asset you are purchasing serves as collateral.

You will probably have to pay off these loans over time (especially a mortgage), so you will probably end up paying back more than you borrowed. Let's say you take out a 30-year mortgage for $250K at 3.8% interest: you'll end up paying $420K for it—$250K plus $170K in interest.

Sneaking debts inside your pocket

Another way people get tempted to spend more money is to earn credit card points, cash back, or airline miles. The rewards are nothing more than debt disguised as a deal!

You may not even realize there's another form of debt—it's inside your pocket. Cell phones are a sneaky debt because we often sign a two-year contract without thinking twice and agree to make monthly payments for the next two years. But the debt is secured. While it may not seem like much, you still owe money on that device.

Is there good debt vs. bad debt?

The truth is, there's no such thing as good debt. To say there is good debt is more like saying there are good flu strains. As an example, let's look at student loans. It is a common misconception that student loans are "good debt" because they're an investment in a student's future.

In reality, loans slow the borrower down and hold him back for a long time. Quality education can help your career, but student loans aren't the only means.

How about a mortgage? There's no doubt that a mortgage is a debt, but it's the only one you won't get raked over the coals for. If you cannot buy a home outright, we recommend a fixed-rate 15-year mortgage, with your monthly payment being less than 25% of your total income. Furthermore, you should save 10-20% towards your down payment.

Learning about financial planning, saving for retirement, and credit card basics can all help you decide where you want to take your finances. If you feel that your debt is out of control, or you would like to learn more about strategies to manage debt, visit SoloSuit.

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How it works: SoloSuit is a step-by-step web-app that asks you all the necessary questions to complete your answer. Upon completion, you can either print the completed forms and mail in the hard copies to the courts or you can pay SoloSuit to file it for you and to have an attorney review the document.

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