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Debt is any amount a borrower owes a lender. From an economic standpoint, the money a borrower receives in a loan is really an advance on future earnings.  The debt represents an obligation to use a portion of future periodic earnings to pay back the debt over time. 

Debt comes in many forms.  For individuals, it is usually in the form of credit card balances, a home mortgage, car loans, and personal lines of credit.  Businesses and corporations have more options, including trade payables, bonds and commercial paper.

On the lender’s side of the debt transaction, the borrower pays the lender interest as compensation for the lender’s potential risk of not being paid back the amount that was loaned. The interest rate is based on the lender’s assessment of risk - the riskier the loan, the higher the interest rate.

Debt allows a borrower to make high-value purchases without having the entire amount of cash on hand to make the purchase.  Most homeowners would not have been able to purchase their home without borrowing the money and then using a portion of their income to make monthly mortgage payments.

Corporations also finance their high dollar purchases with debt, often for the same reason – they lack the necessary funds.  The smart use of debt can make a business more profitable, for example, using the borrowed funds to buy equipment for systems that increase the profitability of the business. This form of value enhancement is known as leveraging debt.

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