Types Of Debt: What You Need To Know
Acquiring personal debt is a fairly common part of modern life. Whether you’re paying off medical bills, pursuing a college degree or renovating your dream home, larger expenses often require you to take out loans or lines of credit in order to be able to afford them.
To ensure that you’re making the best choices for your finances, it’s important to be familiar with the different types of debt you could potentially be taking on and what they could mean for you.
Let’s go over the types of debt you’ll be most likely to encounter, plus what makes debt "good" or "bad" and how to best manage the debt you take on to maintain your financial well-being.
Common Types Of Personal Debt
There are many different kinds of debt individuals can accumulate, but here are some of the broadest and most frequently used types:
Secured debt is an amount of money borrowed that has been backed by some form of collateral asset (thereby securing funding with the lender by ensuring that their investment won’t be a total loss if the borrower is unable to make monthly payments). Auto loans, for example, are a form of secured debt, as the borrower’s car will be repossessed by the lender if they fail to keep up with their payments.
Mortgages are the most common type of secured debt taken on by consumers. These types of loans are secured by the house itself – if the borrower fails to pay their mortgage each month, the lender will be able to foreclose upon the property and sell it at auction. Lenders most often approve mortgage loans for 15- or 30-year terms. The longer loan terms tend to make it easier for borrowers to keep up with their monthly payments and avoid foreclosure.
Unlike secured debt, unsecured debt does not involve the use of collateral assets between the borrower and lender. Instead, the borrower simply enters a contractual agreement with their lender based on their creditworthiness, and if they fail to make their monthly payments, the lender is able to file a lawsuit in an effort to get their money back.
Unsecured debt also tends to have higher APR / interest rates and lower borrowing limits than secured debt due to the increased risk for the lender. Popular examples of unsecured debt include student loans and some personal loans.
Installment debt is a type of debt for which the borrower receives all of the money they’ve been approved for up front, then pays it back in consistent monthly increments for a predetermined length of time. It can be secured or unsecured, and portions of the monthly payments typically go toward interest and principal. Traditional mortgage loans and auto loans are some of the most recognizable examples of installment debt.
Revolving debt is a type of debt accrued on a line of credit with a limit set by the lender. Unlike installment debt, revolving debt is paid off as needed so the balance on the credit line isn’t exceeded and can be reused by the borrower. It can be secured – a home equity line of credit, for instance, is a secured form of revolving debt because it’s backed by the borrower’s equity in their home – or it can be unsecured, in the case of a credit card.
Good Debt Vs. Bad Debt
While there are some who would argue that no debt is good debt, there are certain types of debt that will ultimately prove to be beneficial to borrowers in the long term. If you’re taking on student loan debt to forward your education, for example, you’re investing in your future and generally increasing your chances of finding employment with greater earning potential.
If you’re taking on mortgage debt to purchase a home, you’re investing in a living space that will provide you with comfort and independence for years to come; if you take on a personal loan debt to renovate that home, you’re increasing your enjoyment of the property while you’re living in it. Home renovation also increases the likelihood that you’ll one day be able to sell the property for a profit.
Bad debt, on the other hand, is accumulated by making purchases that will depreciate in value over time or that will worsen the overall state of your finances. Using a high-interest credit card to handle impulse purchases, book a vacation or buy cheap clothes, for instance, would be considered by many to be a sure-fire way to increase the amount of bad debt you have to pay off.
How To Manage Your Debt
The key to effectively managing your debt, no matter what type you have, is staying on top of your monthly payments.
Failing to make payments, whether it’s in predetermined installments on a secured loan or in fluctuating amounts on an unsecured line of credit, can lead to a whole host of financial issues. Your collateral assets could be seized, your lender could sue you, your credit score could plummet – and you could have difficulty getting approved for other loans or lines of credit should you need to take on additional debt in the future. Successfully practicing debt management means consistently paying down your debts on the schedule you’ve committed to with your lender, so it’s crucial that you do everything in your power to uphold that commitment.
However, if your debt payments become overwhelming, it might be helpful to consider consolidating your debt. If you have multiple sources of debt, condensing all of the payments into one monthly expense can sometimes make it significantly easier for borrowers to move financially forward, stick to their commitments and continue paying back the money they owe.
What Type Of Debt Has The Highest Consumer Debt Balance?
According to Experian’s ongoing analysis of credit and debt in the United States, the largest source of consumer debt is mortgages. Roughly 44% of all U.S. adults currently have a mortgage, and consumer balances on mortgage loans grew by 2% in 2020.
What Two Types Of Debt Are Most Common For Millennials?
While your first instinct might lead you to believe that student loans are the biggest source of debt for millennials, credit cards are actually the driving force behind Gen Y debt. According to a study by Nitro College, over 70% of millennials have some amount of credit card debt, while only 58% have student loan debt.
What Type Of Debt Is Credit Card Debt?
As mentioned above, credit card debt is considered a form of revolving debt, as it’s accumulated on a line of credit and paid off when necessary so the borrower can have repeated use of the line. More often than not, debt accrued from credit cards is unsecured.
What Type Of Loan Can Be Used For Debt Consolidation?
There are a few types of loans that can be used to consolidate debt, but a personal loan is oftentimes the best option for borrowers. In fact, some companies (like Rocket Loans) offer debt consolidation personal loans that are specifically geared toward assisting borrowers with bundling their debts into a single, more manageable monthly payment.
Before you decide to take out a loan or a line of credit, it’s wise to consider which type of debt would best suit your specific needs. Think about the reasons behind why you need access to more funding and why you’re willing to take on more debt to achieve a particular goal, and weigh your options accordingly.
Taking on debt is a long-term commitment, and you want to make sure that the terms surrounding the option you choose fulfill their purpose without severely damaging your finances.
Ready to get started? Apply for a personal loan with Rocket Loans today!
What Is The Best Way To Pay Off Debt?
Wondering the best way to pay off your debt? Read our guide for basic guidelines you can follow when paying off your debt.