Financial Dictionary -> Debt

There are tons of books and articles written on the topic of debt, and rightly so. Most people lack even basic financial education and this is one of the reasons for the never before seen extremes in personal indebtedness. This section of Financial Dictionary tries to shed a light on several debt related topics.

Types of Debt and Purchases

Every debt starts with a credit, and helping understand credit will help you understand debt better. Basically, debt refers to money owed to a third party, whether a private person or financial institution such as bank, finance company, credit card issuer, or credit union. Securitization trusts, businesses, and governments are also debt issuers. Debt is a method to expand business operations, start a business, make large purchases, start a home improvement project, buy a new or used vehicle, or pay unexpected expenses. People borrow money for different reasons – to pay discretionary expenses or repair bills, cover medical expenses, pay unexpected travel expenses, funeral expenses, insurance premiums, utility bills, etc. People also borrow to pay balances on maxed out credit cards. Credit card debt can be costly, especially if you use high interest cards. In this case, a low interest loan can help deal with high rate debt. Depending on the purchase or loan purpose, there are different types of debt – new and used car loans, consumer and commercial mortgages, student and consumer loans, credit cards, and individual and business lines of credit. Other types of debt include peer to peer and payday loans, cash advances, real estate debt, loans from friends and family, consolidated loans, and others. Finance experts also differentiate between good and bad debt. Loans taken out for assets that increase in value such as real estate are considered good debt. Student loans are also a good example. Other types come with high or extremely high interest rates, for example, payday loans and department store credit cards.

Debt can also be divided into closed-ended and open-ended, revolving and installment, and secured and unsecured. There are some types of loans to avoid such as advance fee loans and short-term loans offered by predatory lenders. Predatory lending is illegal and often leads to debt spiraling out of control. It is usually borrowers with low income and multiple loans who become victim of loan sharks.

How to Avoid Debt

Using multiple credit cards is not a good idea because cards have different due dates. Missed and late payments mean penalty interest rates and other charges. Obviously, financial planning is very important. If you plan on buying a big ticket item, then it is a good idea to develop a savings plan instead of charging the purchase on your credit card. This will save you money in interest, and you will have more cash for other purchases. Learning how to do things by yourself also helps save money. If you are interested in remodeling or renovation, you may want to learn how to do things by yourself.

Ways to Deal with Debt

There are different ways to deal with debt, depending on the types of loan, interest rate, and amount. If you have excessive debt, the first step is to develop a household budget to sort out your finances. List all household expenses and loan balances you can think of – grocery shopping, bills, high interest card balances, life, vehicle, and home insurance, and others. Make a list of your monthly income and compare. The next step is to choose the best method to deal with debt. Bankruptcy is the worst case scenario and last resort for debtors who have exhausted all other options. Other methods include consumer proposal, consolidation, and individual voluntary arrangements. You can also try formal proposal, debt restructuring, and negotiation with creditors. Self money management is a good option for consumers with small debt, good financial discipline and money management skills, or both. In this case, the goal is to find ways to cut down expenses or increase your monthly income. Obviously, taking no action is not an option. You risk losing a valuable asset or you will end up knee-deep in debt. Another option is to ask your friends, family, or colleagues for a small loan to deal with high interest debt. Selling some property is yet another option. You can sell some of your belongings, a second vehicle, or stuff you no longer need. Selling your coin collection or antiques is also a way to free cash and pay off your debt. You may want to contact an appraiser to determine the real value of your valuables. You can organize a garage sale or auction to sell some of your stuff. If you have a mortgage, you may consider restructuring it. Discuss a new repayment plan with your financial institution. This is also a way to save money.

Debt restructuring and consolidation are other methods to put your finances under control. Consolidation takes different forms. If you use high interest credit cards, one option is to transfer the existing balances to a new card with a long introductory period. A credit card with zero interest during the introductory period is an excellent choice. The main benefit for borrowers is that they save money in interest payments. Moreover, customers have one monthly payment to take care of instead of multiple payments with different due dates and interest rates. A repayment arrangement is another alternative of bankruptcy. It is known as individual voluntary arrangement and usually involves a repayment period of 5 years. A portion of the debt is written off. Finally, bankruptcy is a solution under certain circumstances but depends on the types of debt held. In any case, it is a good idea to check your credit report to make sure there are no errors or omissions that make your credit score plummet. You are entitled to a free report once a year, issued by the major credit bureaus.

Here you can learn about credit bureaus that keep records of your credit history, and get facts about your credit report. People with several high-interested debts, may be interested in learning more about debt consolidation. If you want to invest in the stock market, then understanding what is company's Debt-Equity Ratio is a must.

Other debt related terms of more unpleasant flavor are bankruptcy, foreclosure, default, delinquency, liability, lien, and collection agency.

Although the topics discussed in our debt section might not be the favorite for a table conversation, they are still very important, for one's financial well-being.