The meaning
Debt is simply money you owe to another person or entity. Legally, you’re required to pay back this amount of money to the borrower within a specific time period, usually with a cherry on top (aka interest). It’s basically “money you rent”.
Why would I pay back the money with interest?
As a rule of thumb, the sooner the borrower pays back the money, the lower the interest. So, the latter is a way to encourage individuals to pay back the debt before the payment deadline. And, it is compensation for the lender as he/she took the risk of lending money.
In the finance lingo, the debtor means borrower and debtee means the lender.
What are the different types of debt?
Secured debt
A secured debt is a loan that is tied to an asset or property that is valuable enough to cover the amount of debt. So, if the borrower failed to pay back the money, the asset will be taken by the lender, in exchange for the money they owe.
Unsecured debt
Unsecured debt is a loan that is not secured by any assets. The money is mainly given based on the borrower’s credit rating, which indicates the borrower’s ability to pay back the money. Credit card debt is an example of unsecured debt.
What are some examples of debt?
Debts can take many forms. It could be a credit card bill, a loan from a bank, house installments, student loans, or even money you borrowed from a friend or a family member.
Good debt vs. bad debt
Debt usually has a bad connotation. What’s good about owing money to others, right? Yet, believe it or not, there’s good debt. What differentiates between good debt and bad debt is the value in the long term.
If you borrowed money to pay for valuable things that will benefit you in the long run, then this is good debt. A great example of good debt is education, which supposedly will greatly impact your career (and later your salary).
On the other hand, bad debt is money you borrow to pay for things that don’t create value with time, like a new iPhone or a jersey jacket.
The same applies to companies. It can be a great indicator when a company takes out a reasonable amount of debt to finance big projects, which will end up generating more money for the business in the long run. However, if a company takes on debt in order to pay salaries, that’s a red flag.
Yet, how can you determine whether the debt was taken for the right reasons? Check out this article to learn more about how to analyze a stock.
Why do people go into debt?
Why do people go into debt in the first place? Here are a couple of examples:
Overspending
This happens when you spend more money than you earn, and it can quickly add up. For example, if you have a credit card with a high limit and you regularly make purchases that exceed that limit, you will start to accumulate interest charges. This can quickly add up and make it difficult to pay off your debt.
Not having a budget
A budget is a plan for how you will spend and save your money each month. Without a budget, it can be easy to overspend and end up with more bills than you can afford to pay.
How can I get out of debt?
First things first, you have to track your spending and save up some money on the side to pay off the debt. If your spending is higher than your income, then you should try to lower your expenses.
Our budgeting tool can help you track your spending with ease.
The next level is to pay off your debt. Check out this article to know how.
