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A Guide to Defining Your Debt

 

What Is Debt?

The vast majority of us have debt. Why? Simple, 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 may be depressing, but ignoring it won’t make it go away. 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.

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The Difference Between Secured and Unsecured Debt

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 borrow money for something that has real value, or collateral, you are taking out a secured loan. This means lenders have something of yours to take back if you should default on that loans. The lenders take less risk, which generally means they can offer a lower interest rateThe better your credit score – anything above 720 is usually considered excellent credit – the lower the interest rate you may qualify for. For large loans, like auto loans or mortgages, you could save hundreds of dollars each month. Make sure to check your credit report periodically to make sure it doesn’t contain any errors that can hurt your score.

The most common forms of secured debt are mortgage loans and auto loans. With a mortgage loan, lenders can take your house, a process known as foreclosure, if you fail to make your loan payments. With auto loans, 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, meaning the banks and lenders take more risk. To make up for this, lenders charge higher interest rates. 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.

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Differences between Revolving, Installment and Open Debt

Revolving debt is the kind of debt you have on your credit cards. 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. However, if you pay your monthly balance because you want to, not because it’s required, the debt is not truly revolving.

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Other Types Of Debt

Installment debt, unlike revolving debt, is consistent from month to month. Examples of this include mortgage and car loans. Installment loans are any debt that you are expected to repay 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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