Great Lakes Credit Union has everything you need to help manage your money and plan for the future.
Money SmartsMarch 11, 2022
Debt is more prevalent than ever in today’s society. Data shows that consumer debt has grown to more than $14.9 trillion in recent times, with the average consumer having about $92,727 in debt. And as it becomes more common, it becomes increasingly important to understand how to manage debt.
What is debt?
Debt is created when something, usually money, is borrowed by one party from another. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest.
A loan is a form of debt but, more specifically, is an agreement in which one party lends money to another. Qualifying for a loan requires an approval process to verify the creditworthiness of the borrower and their ability to pay. There is a review of income, employment status, credit score and payment history on other loans and bills and may include verifying collateral to determine its value. The lender sets repayment terms, including how much is to be repaid and when. They usually establish that the loan must be repaid with interest which is expressed as a percentage of the loan amount. Interest is used to ensure that the lender is compensated for taking on the risk of making the loan.
Types of debt
Debt falls into four categories: secured, unsecured, revolving and installment. These categories can and do often overlap. Understanding how loans are classified—and how the classifications work—can help you with your financial decisions
-- A secured loan is a loan backed by collateral. The most common types of secured loans are mortgages and car loans, and in the case of these loans, the collateral is your home or car. In addition to the standard review of income, employment, credit score and payment history, the collateral is typically verified and its value is assessed.
-- When you take out a secured loan, the lender puts a lien on the asset you offer up as collateral. Once the loan is paid off, the lender removes the lien, and you own both assets free and clear.
-- Secured loans represent lower risk to the lender which could mean more favorable financing terms and rates for the borrower.
-- Types of secured loans:
-- Secured credit card (cash deposit)
-- Types of collateral (depending on the type of loan):
-- Real estate
-- Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
-- Vehicles (cars, trucks, SUVs, motorcycles, boats, etc.)
-- Stocks, mutual funds or bond investments
-- Insurance policies, including life insurance
-- High-end collectibles and other valuables (precious metals, antiques, etc.)
-- Unsecured loans do not have any collateral behind them though you are still charged interest
and, sometimes, fees.
-- Since there’s no collateral, financial institutions approve or deny unsecured loans based largely on your credit score and history of repaying past debts. For this reason, unsecured loans may have higher interest rates (but not always) than a secured loan. Lenders examine your credit by using credit reports.
-- There are roughly 20.2 million personal loan borrowers in the U.S. You can take out a personal loan for nearly any purpose, whether that’s to renovate your kitchen, pay for a wedding, go on a dream vacation or consolidate debt.
-- Types of unsecured loans:
-- Student loans
-- Personal loans
-- Credit cards (traditional)
-- A revolving credit account is open-ended, meaning you can charge and pay down your debt
over and over—as long as your account stays in good standing.
-- If you qualify for a revolving credit line, your lender will set a credit limit, which is the
maximum amount you can charge to the account. Your available credit then fluctuates each month, depending on how much you use it. Minimum payment amounts may change every month too. Any unpaid balance carries over to the next billing cycle with interest added on.
-- Types of revolving loans:
-- Personal line of credit
-- Home equity line of credit (HELOC)
-- Credit cards
-- This type of loan is closed-ended, meaning that it’s repaid over a fixed period of time and
payments are made in equal installments (often monthly).
-- Installment loans can be secured. That’s the case with auto loans and mortgages.
-- Installment loans can also be unsecured. That’s the case with student loans.
-- When you make installment loan payments, you’re paying what you borrowed and interest at
the same time. Often, the portion of each payment that goes toward interest decreases as the loan is paid down. This process is known as amortization.
-- Types of installment loans:
-- Auto loans
-- Mortgage loans
-- Student loans
Understanding your loans
It’s important to know about and fully understand each loan you have. For each loan, you should know your:
-- Total balance
-- Interest rate
-- Minimum monthly payment
-- Estimated payoff date
Once you understand your loans, you need to have a payoff plan for each one and make sure you are comfortable with the plan in light of your personal budget.