Debt: What is it and how do we Pay it Off?

April 8, 2024

by Christian Phillips

Debt refers to money that one person or entity owes to another. It is common practice among individuals and organizations to borrow money to make big purchases that they may not be able to afford otherwise.

How it works:
You might be familiar with several common forms of debt, such as mortgages, auto loans, student loans, and credit cards. When you borrow money, you receive a set amount and are required to pay it back in full or in installments within a specified timeframe. The terms of the loan also stipulate the amount of interest that you are required to pay. The main purpose of interest is to compensate the lender for taking on the risk of the loan.

Types of consumer debt:

Mortgages:

Mortgage is a type of secured debt used to purchase real estate. Typically, they are paid back over more extended periods, such as 15 or 30 years.

Unsecured:

Unsecured debt is a type of debt that does not require collateral as security. The lender assesses your creditworthiness based on factors such as your credit score, credit history, and other essential criteria. Examples of unsecured debt include most credit cards and personal loans. Since unsecured debt is riskier for lenders, it usually comes with higher interest rates than secured debt.

Secured:

Secured debt, also known as collateralized debt, is a type of loan where the borrower pledges an asset of value. If the borrower fails to make payments, the lender can seize and sell the asset to recover the losses.

Revolving:

Revolving debt provides the borrower with a line of credit. The amount is predetermined, and the borrower can utilize the line of credit at their convenience. The most common form of revolving debt is credit cards.

Advantages and Disadvantages:

Advantages:
Debt can benefit a significant number of consumers if it is managed and used appropriately. Only a limited number of people can afford substantial purchases like a house, car, or other big-ticket items without debt. By using these resources, you can work towards achieving personal goals such as owning a new home or car.

Disadvantages:
Mismanagement of debt can rapidly result in overwhelming financial difficulties. This can occur when you spend more money on credit cards than you can afford to pay back, take on an expensive car payment, or commit to a mortgage before you are financially prepared.

How to pay off debt:
If you find yourself struggling with insurmountable debt, it's essential to take action to start paying it off. Here are some steps you can take:

Stop using open credit lines and do not inquire about an additional loan.
Prioritize paying off debts with the highest associated interest rates.
Simplify your life and look for areas to cut back on. This will allow you to allocate more of your income to paying off debt.
Ask your lender about consolidating your debts. This option might make sense if the new loan carries a lower interest rate.
Transfer credit card balances. If you're lucky, transferring your balance may result in a lower interest rate or even a zero percent interest period. If this promotion is offered, take advantage of it and pay down as much as possible.

Keep track of billing statements.
Pay more than the minimum balance.
Pay more than once a month.

If you have questions or concerns about managing or taking on debt, contact your local banker.

Debt: What is it and how do we Pay it Off?

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