A Guide to Defining Your Debt
We all have debt. Well, the vast majority of us, at least. It’s hard to make it through this world without incurring some form of debt.
But how well do you understand the debt you have? Do you know the difference between unsecured and secured debt? Do you know the difference between revolving, installment and open debt?
No one likes to look at their debt too closely. Personal debt is the definition of a depressing subject. But, it’s important for you to understand not only how much debt you have but what kind. Having this knowledge can guide you as to what debt to pay down first and what kind of debt you should take on.
And in a bit of good news, you’ll find that debt really isn’t that hard to understand.
Your first lesson is to learn the difference between secured and unsecured debt. When you take out a secured loan, you are bringing collateral to the table. This means that lenders have something of yours to take back if you should default on your loans. This is important; it means that lenders take on less of a risk. That usually equals lower interest rates. If you have a good three-digit credit score – anything above 720 is usually considered excellent credit – you’ll generally qualify for the lowest interest rates. Depending on the size of the loan that you take out, this can save you hundreds of dollars each month.
Some of the most common forms of secured loans are mortgage loans and auto loans. In a mortgage loan, lenders can take your house, a process known as foreclosure, if you fail to make your loan payments. For an auto loan, lenders can repossess your car if you stop making payments. That’s what collateral is all about.
Unsecured loans, not surprisingly, are the opposite. Borrowers don’t come with any collateral. This means that banks and lenders take on more risk. They don’t have any assets to take should you start missing payments. To make up for this, they charge higher interest rates on unsecured loans. It’s why most borrowers prefer secured loans to unsecured ones.
Some common examples of unsecured loans include personal loans, student loans, credit cards and personal lines of credit.
You should also know the differences between three kinds of debt: revolving, installment and open.
Revolving debt is the kind you rack up on your credit cards each month. Each month, your debt balance varies depending on your spending over the last 30 to 31 days. The money that you don’t pay is rolled over, or revolved, to the next month’s payment.
A good example of installment debt is your mortgage loan. This is any money owed to a creditor who expects you to repay the loan over a fixed amount of time usually in equal amounts.
Open credit is the rarest of the three. Under this debt arrangement, you run up debt for a month and then pay it off in full with your payment. This is how the American Express card works. It’s also how your cell phone bill works.
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