The Main Types of Debt
A debt is an amount of money that is borrowed from one party by another. A debt can actually help a person or a company out of a financially stressful situation. However, it is important that you understand all about debts before you opt for one. Following are the main types of debt.
Mortgages (liens against property/claims on property)
A mortgage is what comes to your mind when you first think about buying a home. It is, in fact, one of the most common debts that a large number of people carry. In this type of debt, the home or the real estate property serves as a collateral for the loan. The mortgage will have to be paid back over a period of many years with a set of payments that is predetermined. (Mortgages are loans with monthly payments). Once the full mortgage is paid back with interest, you will own the property/home. You can either opt for a fixed-rate mortgage, where the interest rate remains the same or opt for an adjustable-rate mortgage, where the interest rate changes in accordance with the market interest rates after the initial term. Now, in the case you stop making the payments, the bank has the right to foreclose.
Secured and Unsecured Debt
As the name suggests, a secured debt is when you take a loan by pledging any of your assets, such as your car or your property, as collateral for the loan. The lender will place an ownership claim (lien) on the asset's title, and provide you the money. In the case you fail to make the payments, the lender will take possession of the asset. He/she may sell it to regain the amount that he/she loaned. If the asset fails to bring in the loan amount, the lender can get a deficiency judgment against the borrower. The interest rates on secured loans are usually reasonable. Of course, your credit score matters, if you have a good credit score, you will easily get the loan with an attractive interest rate.
An unsecured debt is when a lender provides a loan without holding any asset as a collateral. It is provided mainly based on the ability of the borrower to pay the amount back. You will have to sign an agreement, and if you fail to pay the loan back, the lender would be able to sue you to reclaim the amount. Since an unsecured debt comes at a high risk for the lender, the interest rates are usually higher. Education loans, personal loans/signature loans, home improvement loans are all examples of unsecured loans.
A typical example for a revolving debt is a credit card. There is a limit for the credit card, and you will only be able to spend up to that limit. In effect, a revolving debt lets you borrow up to a limit on a recurring basis. A revolving debt is a typical example for an unsecured debt.
No matter what type of a debt you opt for, always read and understand the terms and conditions.