Types of Debt
Not all debts are created equally. Some forms of debt offer powerful advantages that millions of consumers and businesses utilize to manage their finances more effectively & buy things they need. Student loans help thousands progress their education & create new opportunities, while mortgages allow many families to own a home when they would not otherwise be able to.
On the other hand, an unpaid debt can destroy your credit score or lead to the complete loss of a home or vehicle. Borrowing too much can create a level of debt that can quickly lead to financial disaster.
With debt & credit playing a major role in the financial lives of many Americans, it is necessary to know the different types of debt that one can encounter. Not all debts are bad.
Select a Type of Debt:
Three Main Categories of Debt
Secured debts are all backed by an asset (aka collateral) such as a car or a property. When a borrower cannot pay a secured debt, the lender is allowed to seize the collateral that was originally used to secure the debt. Mortgages and auto loans are examples of this type of debt.
Since borrowers have more to lose with a secured debt, these types of loans are typically offered at lower interest rates than those for unsecured debts.
Unsecured debts are not backed by any underlying assets for collateral. When a borrower is unable to pay an unsecured debt, the lender is usually unable to claim any assets as payment for the debt.
Despite a lenders inability to directly collect on an unsecured loan, they can come after your assets & credit through indirect channels such as:
- Hiring a debt collection agency to pursue the borrower for the amount owed
- Suing the borrower. With this type of lawsuit, a lender can ask the court to repossess an asset, put a lien on your assets, or even garnish your wages until the debt is repaid.
- Reporting on the delinquent status of the borrower’s payment to the credit bureaus. Reported late payments negatively affect your credit score & appear on your credit report.
A revolving debt comes from loans that allow consumers to borrow a maximum amount on a recurring basis. These types of debts can be secured or unsecured and are most commonly seen in the form of credit cards or home equity loans.
Common Types of Debt
|Debt Type||$ Amount Owed by Average U.S Household in Debt||Total Owed in United States||% of Total|
|All Debt||$135,768||$13.51 Trillion||100%|
|Credit Card Debt||$6,929||$420.22 Billion||3.10%|
|Mortgage Debt||$184,417||$9.14 Trillion||67.60%|
|Auto Loans||$28,033||$1.27 Trillion||9.40%|
|Student Loans||$47,671||$1.44 Trillion||10.66%|
Data from Nerdwallet’s 2018 debt analysis shows that mortgage debt is still the largest form of debt by far in the United States with nearly $185,000 owed by the average American household in debt.
Real estate purchases are generally the most expensive investment individuals make, but mortgage debt also tends to carry the lowest interest rates. Mortgages are secured debts as the purchased property is used as the collateral. They are often given in 15 or 30-year terms in order to keep monthly payments affordable for the consumer.
This type of loan comprises most of the debt that American consumers have accrued with over $9 trillion in total home loan debt in the United States.
Types of Mortgage Loans
- Conventional Loans: 15 or 30-Year term loans that are not insured by the government. Down payment of 20% or more of the purchase price preferred for this type of mortgage loan.
- Federal Housing Administration (FHA) Loans: Promotional loan for first-time homeowners that is covered by a loan guarantee. As little as 3% of the overall purchase price can be used as down payment for this type of mortgage loan.
- Veterans Administration (VA) Loans: Guaranteed loans for service members and eligible, surviving spouses that require little to no down payment in sales where the property price is equal to or less than the appraised price.
- Interest Only Loans: Home loans for borrowers with good credit. Interest is paid on the mortgage interest for a 5 or 10-year term, after which the rates go up. This type of mortgage can be a fixed or adjustable rate loan.
- Home Equity Loans: This type of mortgage takes money out of your house through a home equity line of credit (HELOC).
Credit cards offer consumers a convenient method of borrowing money on a revolving basis. Most consumers have credit cards, but this type of debt comprises just over 3% of the overall debt in the United States.
Credit card debt offers unique advantages with: reward perks, fraud protection, and a good opportunity to build credit. But it is also often accompanied by exceedingly high-interest rates (12-25%) & late fees.
Although most credit cards come in the form of unsecured debt that is not backed by collateral, there are also secured credit cards that require a deposit or down payment before purchases can be made.
Attaining a college degree is nearly impossible for many students without some form of borrowing money to pay for education. Roughly 44 million young Americans are currently paying off debt from a student loan.
Despite the large volume of students who have undertaken a student loan, this type of debt comprises only 10.66% of the overall debt in the United States. What may be more surprising, is that this type of debt dwarves that seen from credit cards in America by over 3x the amount ($1.44 Trillion vs $420.22 Billion).
Student debt can come from government or private loans. Although these two types of loans are similar in nature, they can vary hugely in interest rates and term periods.
Federal and state-funded student loans can be applied for with the Free Application for Federal Student Aid (FAFSA) form. Government-funded loans often require a lower credit score to be approved for & these loans can be subsidized.
Private student loans have higher average interest rates compared to federal loans & are never subsidized. This means that the borrower is never excused from paying the interest expense, even during education.
As businesses look to expand, many companies take on corporate loans to accommodate their need for extra capital. However, repaying of these loans has proven to be difficult for many business owners as the corporate debt in America grew to be over $9 trillion by the end of 2018.
Business debt is unique in the sense that most of it is not covered by the Fair Debt Collection Practices Act (FDCPA), so these types of loans have fewer protections against the unlawful conduct of debt collectors.
Auto loans had accumulated over $1.2 trillion in debt by the end of 2018 but are still the second smallest type of consumer debt in America. These types of loans are often offered with simple interest rates or a pre-calculated total amount of interest to be paid.
Making a larger down payment for an auto loan can significantly reduce the overall amount of debt from the purchase.
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