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DEFINITION of 'Toxic Debt'

Debt that has a lower chance of being repaid with interest. Toxic debt is toxic to the person or institution that will receive the payments.

This debt generally adheres to one of the following criteria: default rates for the particular debt are in the double digits, more debt is accumulated than what can comfortably be paid back, the interest rates of the obligation are subject to discretionary changes. Any debt could potentially be considered "toxic," if it imposes harm onto the financial position of the holder.

BREAKING DOWN 'Toxic Debt'

Debt is not always bad, especially if you are the lender and the borrower is making the payments. If the payments on these loans stop coming in, or are expected to stop, the debt becomes known as toxic debt. The historical costs of toxic debt securities are higher than the current market price. This can often result from unjustified high credit ratings which implies that the risk of default on the security is much lower than fundamental analysis would suggest. Junk bonds are not classified as toxic debt upon purchase, because the buyer is aware of the underlying risk of these securities.

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