Comprehensive Guide To Understanding Different Types Of Debt

Money SmartsJanuary 24, 2025

Most Americans will take on some form of debt during their lifetime. Smart borrowing requires careful consideration of interest rates and repayment terms. Read on to learn more about different types of debt and how they impact your financial future.

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, it’s an agreement in which one party lends money to another. Qualifying for a loan requires an approval process to verify the borrower's creditworthiness and ability to pay. 

The lender reviews income, employment status, credit score, and payment history. They may also verify collateral to determine its value. Repayment terms are then set, including how much will be repaid and when.

They usually establish that the loan must be repaid with interest, expressed as a percentage of the loan amount. Interest ensures 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 make smart financial decisions.

Secured Debt

Secured debts, such as mortgages and car loans, are backed by collateral like your home or vehicle. During the application process, lenders will review your income, employment, credit score, and payment history. Additionally, they’ll also verify and assess the collateral’s value.

When you take out a secured loan, the lender puts a lien on the asset you offer up as collateral. Once you pay off the loan, the lender removes the lien, and you now own the asset. Secured debt represents a lower risk, which could mean more favorable financing terms and rates.

Types of Secured Debts

• Mortgage
• Cash
• 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 Debts

Unsecured debt operates without any collateral backing the loan. Financial institutions must rely solely on credit scores for approval decisions and often charge higher interest rates to protect against default risk. 

Personal loans represent a significant portion of unsecured lending in America. As of 2023, Americans hold roughly $58.61 million in personal loans and $28.86 million in unsecured loans.

Unsecured personal loans offer extensive flexibility for various financial needs. Borrowers typically use these loans to fund home renovations, wedding expenses, vacation costs, or debt consolidation projects.

Types of Unsecured Debts

• Student loans
• Personal loans
• Credit cards

Revolving Debt

A revolving credit account is open-ended, meaning you can charge and pay down your debt repeatedly—as long as your account stays in good standing. Your lender will set a credit limit based on your qualifications. This determines the maximum amount you can charge to the account.

The available credit fluctuates monthly, depending on how much you use it. Minimum payment amounts may also change every month. Any unpaid balance carries over to the next billing cycle with interest added.

Types of Revolving Debt

• Personal line of credit
• Home equity line of credit (HELOC)
• Credit cards

Installment Debt

This type of loan is closed-ended, meaning that it’s repaid over a fixed period. Payments are made in equal installments (often monthly). Installment debt, such as auto loans and mortgages, can be secured.

However, installment debt can also be unsecured, as is the case with student loans. When you make installment loan payments, you pay what you borrowed, as well as interest on the loan. The portion of each payment toward interest often decreases as the loan is paid down, in a process known as “amortization.”

Types of Installment Debt

• Auto loans
• Mortgage loans
• Student loans

Debt Payoff Methods

Getting out of debt is no easy feat, and it can take months to years to recover fully. However, the sooner you start, the sooner you’ll be on the road to financial freedom. Taking proactive steps can also help reduce the amount of money you’ll pay over the long run.

The debt avalanche method focuses on high-interest debt first. You will make minimum payments on all debts during this process. Any extra money goes toward the highest-interest debt balance. After paying off each debt, you will move to the next highest interest rate. This method will save you the most money in interest over time.

The debt snowball method targets your smallest debts first. Through this process, you will make minimum payments on all debts, and the extra money goes toward your smallest debt balance. Each small debt payoff creates momentum (snowball) for tackling bigger debts. Many people stay motivated by getting quick wins from this method.

A debt calculator can show you the best method for your situation. The calculator will compare total interest costs between both methods. Your payoff timeline might vary between these approaches. The most effective strategy is one you can follow consistently until completion.

Free debt counseling and online seminars offer additional support in choosing and implementing the right debt payoff strategy. Financial experts, such as CPAs, can review your situation and help create a personalized plan for achieving your goals.

Take The First Steps to Get Out of Debt

Getting out of debt starts with a clear understanding of your total balances, interest rates, and monthly payments across all loans. A successful debt payoff plan aligns these financial obligations with your budget and income.

The GLCU Foundation offers personalized guidance to help you create effective debt management strategies. Click below to schedule a free consultation with one of our financial counselors to help get your debt under control.

Speak to One of Our Financial Counselors Today!

The information in this post is for educational and informational purposes only and does not constitute investment advice. You should consult a licensed financial advisor before investing in any financial product or service. 

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