Types of Debt

Debt is something that many people have to deal with over their lives. However, there are a few different types of debt, each of which has slightly different characteristics. So, when it comes to personal debts, they can be broken down into 4 main categories. This guide will go through each type of debt.

Secured Debt

A secured debt is any debt that has an asset involved that is used as collateral. This reduces the risk of the loan for the lender. So, when using an asset as collateral, this can include a property, belongings, or in some cases money can be used as collateral. However, if you do not keep up with the repayments, whatever you use as collateral is a risk.

With secured debts, it can work in two main ways. Either, first you have to offer something as collateral, and then take out the debt. One example of this is secured credit cards, where cash is used to secure the card. The alternative is when the asset you are buying is used as collateral. This is the case when taking out a mortgage for example. When you take out the mortgage, it is secured against the property you are buying. This means if you do not keep up with repayments, your property could be taken to cover the lender’s losses.

However, by supplying collateral, you are reducing the risk the lender is taking. This could have an effect on the terms the lender offers you. For example, often, providing higher collateral will lead to the lender offering lower interest rates. This depends on the lender and your circumstances, but it’s a question worth asking.

Unsecured Debt

With unsecured debts, there is no collateral involved. A good example of an unsecured debt is a personal loan. As there is no collateral, your credit score is normally a much bigger contributor to determining whether you qualify for a loan or not. But, there are some exceptions, such as student loans, that don’t rely heavily on credit scores.

When trying to determine if you qualify for a loan, a lender will generate credit reports, as well as use your credit score. A credit report is a detailed history of your credit history, taking into account your personal information, credit account history and your payment history. Your credit score is then a summary of your report put into a value.

When it comes to unsecured debt, generally the higher your credit score, the more options you should have from lenders. For example, if you want to get an unsecured credit card, having a higher credit score could have a big impact. A higher credit score could allow you to have a higher credit limit, or lower interest rates. But remember, a higher credit score doesn’t guarantee that you will be accepted for loans or credit cards.

Additionally, if you have an unsecured loan, that doesn’t mean you can miss payments. If you do miss payments, the lender could take legal action, and it could have a massive effect on your credit score.

Revolving Debt

Revolving debt is a type of debt that you get from revolving credit accounts. So, revolving credit is when a borrower can borrow up to a certain amount repeatedly, provided they don’t exceed the limit. The borrower then pays off your balance of the debt in regular instalments. This repayment frees up space below the credit limit. For example, if you have a credit limit of £1,000, and spend £800, you still have £200 left below the credit limit. At the end of the month, you could pay £200 back, meaning you will then have spent £600 of your credit.

However, you will normally be charged quite a lot in interest on revolving debt. The best way to avoid interest payments is to pay off the balance of your revolving credit when you get a bill. One example of revolving debt is using a credit card and most revolving credit is also unsecured

Instalment Debt

Instalment debt is similar to revolving debt, except instead of extending, there is a set time period to pay back the debt. Often, the payments are made in equal instalments monthly. This way, you know exactly how much you’ll be paying back each month, and how much the debt will cost you in interest.

Instalment loans can either be secured or unsecured. A good example of a secured instalment loan is a mortgage, where the loan is secured on the property. An example of an unsecured instalment loan is student loans, as there is no collateral for the lender.

While these are the basics of the different types of debt, the type of debt you have could have a big impact on various aspects of your life. Making sure you know if your debt is secured or unsecured could be vitally important, or whether you have to pay your debt off within a set time period. Make sure you read your loan terms carefully, or any credit card terms and conditions. If you don’t, you could be caught out and have to pay huge amounts in interest. The worst case scenario is you could end up losing any assets you secured a loan against. 

Remember it’s easy to get carried away by the availability of the different types of debt and quickly become overwhelmed, especially if any initially low rates end, or your income drops. Beware expensive short term loans and think carefully before taking on any debts.