Debt is by far the greatest impediment to achieving long-term financial independence. It is in many ways like a virus that not only feeds on your financial health today, but on your future as well (which should be even more frightening).
What is debt? It is simply something, usually money, that is borrowed by one party from another. The person or organization that lends out the money is known as the lender and the one who borrows is the debtor. Taking on debt allows people to make a purchase that they cannot afford to pay upfront with cash. It is given under the condition that the debtor is obligated to pay back the money at a later date, usually with interest and on a schedule over time. The original amount of money borrowed is referred to as the principal, while the interest is a set percentage of the balance that adds to the bill on a recurring basis until the debt is paid off. Given how little money in cash the average person has, it is not surprising how widespread debt is in our society.
Before we go further into specifics, it is important to recognize that debt is a necessity for many people, including myself. We all have our own reasons for why that is or what it’s for. This post is by no means meant to demean anyone who takes on debt at one point or another. It is a nearly inescapable reality for most of us. That being said, the reality of debt is a bleak one. By borrowing from others in the present, you are robbing yourself in the future. The money you work hard to earn down the road will not belong to you entirely. Until you are free of your debts, a portion of your money is held prisoner, unusable by you.
You won’t often hear debt described this way, either by those who borrow or those who lend. It has become the mortar that holds everything in our society together. There are many types of debt and reasons to borrow, some of which are wholly justifiable. All I encourage is that you think extremely carefully every time you make the decision to borrow. Decisions without regard for their future impact will set you down a course that will eventually seem impossible to escape.
Types of Debt
There are four main types of debt. They are secured, unsecured, revolving, or mortgaged. Even if some of these types have no relevance on your life today, understanding them now will make you far more prepared on the day when they finally do.
Secured debt is backed by a tangible of financial value, called an asset, which is held as collateral. In this case, the asset is pledged to the lender in the case that the debtor is unable to repay their debt. A car loan is the most common example of this. When a debtor is unable to make their payments on a car loan, the lender has the ability to repossess the car and sell it to recoup the money they lost.
Unsecured debt does not have any collateral. Nothing tangible can be repossessed by the lender in the case of unfulfilled payments. Because of this, unsecured loans tend to have a far higher interest rate than other types, as it is the lender’s way of profiting from the arrangement since it is inherently more risky for them. One of the most common example of unsecured debt is in the form of student loans.
Revolving debt is an agreement that allows the debtor to borrow up to a certain amount of money on a recurring basis. Your monthly credit limit on your credit card is a good example of this. It can take the form of either a secured or unsecured loan, depending on whether or not there is collateral as part of the agreement.
Mortgage is the last type of loan. It is used to purchase real estate. Because a home is often the most expensive purchase most people will ever make, it is also usually the largest debt any person will owe. Mortgages are usually issued for a long-term repayment period, such as 30 years. They also tend to have lower interest rates than other types of loans.
Debt is a massive aspect of finance that is inseparable from the other areas within it. Future posts will dig far deeper into the reasons you should, and shouldn’t, borrow money. Regardless of whatever debt you currently have, I hope this information helped you understand this reality in a way that’s never been explained to you before. Browse the “Debt” category at the bottom of the home page and keep an eye out for future content on this topic!
