Most Americans have some type of debt in their lives. However, debts vary widely with regard to the way they work, their terms, and their impact on your financial health.
Debt comes in several forms, including mortgages, student loans, credit cards, or personal loans, but most debt can be classified as secured or unsecured and as revolving or installment. Learn more about the different categories of debt and how they work.
- The main types of personal debt are secured debt and unsecured debt.
- Secured debt requires collateral, while unsecured debt is solely based on an individual's creditworthiness.
- A credit card is an example of unsecured revolving debt and a home equity line of credit is a secured revolving debt.
- You can also classify debt by its product name, such as mortgages, credit cards, personal loans, or auto loans.
Secured Debt vs. Unsecured
Secured debt is debt backed by an asset used as collateral. The asset is pledged to the lender in case the borrower does not repay the loan. If the loan isn't paid back, the lender has the option to seize the asset.
A car loan is an example of a secured debt. A lender supplies you with the cash necessary to purchase it, but also places a lien, or claim of ownership, on the vehicle's title. If you fail to make payments, the lender can repossess the car and sell it to recoup some of the funds. Secured loans generally have lower interest rates because the collateral lowers the risk for the lender.
Unsecured debt does not require collateral. When a lender makes a loan with no asset held as collateral, it relies on the borrower's ability to repay the loan.
With unsecured debt, the borrower is bound by a contractual agreement to repay the funds, and if there is a default, the lender can go to court to reclaim any money owed. However, doing so comes at a great cost to the lender.
Because it is more risky for the lender, unsecured debt generally has a higher interest rate. Some examples of unsecured debt include credit cards, signature loans, and medical bills.
Revolving vs. Installment
You can also categorize debt by whether it is revolving or installment.
Revolving debt is debt that is open-ended, meaning you can reuse it once you pay down your balance. With revolving debt, you get a maximum credit line and then you can spend up to that limit as many times as you need. The available credit you have will fluctuate depending on how much credit you've used. You must make at least the minimum payments and the remaining balance will then transfer over to the next month with interest.
Installment loans are closed-ended. They work by providing a lump sum, which you then repay the lender in regular payments that are typically the same amount each month and for a set time.
Credit cards are a type of revolving debt. With this debt, you can borrow up to the maximum limit on a recurring basis. When you pay down your balance, you can use that credit again. You credit limit will depend on a number of factors, including your income and credit score.
Credit cards, which are generally unsecured but can also be secured with a deposit, tend to have fairly high interest rates. Some credit cards offer benefits like rewards. A line of credit is loan that is similar to a credit card as it is revolving debt.
Mortgages, the most common and largest debt in the U.S., are loans made to purchase homes, with the property serving as collateral.
A mortgage typically has one of the lowest interest rates of any consumer loan product, and the interest is often tax-deductible if you itemize your taxes. Mortgage loans are most commonly issued at 15- or 30-year terms.
Student loans are loans used to pay for education expenses like tuition and room and board. They are issued in a lump-sum payment, and then the borrower is responsible for making repayments in regular amounts, typically after the student graduates.
Student loans can come from a variety of types of lender, including the federal government. Unlike other types of debt, you usually cannot discharge student loans in bankruptcy.
Car loans are a type of installment loan that is secured by the vehicle you are purchasing. You can get an auto loan through a bank or through a lender connected with a car dealership.
Car loans give you money in a lump sum that you pay back with interest over time, usually from three to six years. Interest rates on auto loans are generally lower than for personal loans because auto loans are backed by the vehicle, which the lender can repossess if you fail to pay.
Other Types of Debt
Personal loans, medical debt, and lines of credit are among the many other types of debt. for individuals. Larger companies may take on corporate debt by issuing bonds, which can trade as securities.
Having lower debt can generally help your credit score and keep you in good financial health, but not all debt is considered bad. Taking on debt can be a good financial move if it can help you build long-term wealth. Debt that is not healthy is debt that has a high interest rate that compounds over time.
Does a Secured Loan Hurt Your Credit?
A secured loan can impact your credit in several ways. When you apply for the loan, your credit score will likely take a brief hit. If you make payments on the loan on time, then the loan could help your credit score in the long-term. However, if you fail to make payments on time, your credit score will likely decline.
What is the Most Common Debt?
The most common debt by total amount of debt in the U.S. is mortgage debt. Other types of common debt include credit card debt, auto loans, and student loans.
What Happens if Unsecured Debt is Not Paid?
If unsecured debt is not paid, you can face a number of negative consequences. Unsecured debt is not backed by collateral, so lenders cannot take your assets. But if you do not pay unsecured debt, you could face fees, penalties, and a wage garnishment. Not making your payments to lenders on time will typically result in a lower credit score, which will make it more difficult for you to get approved for loans and other financial products.
The Bottom Line
Different types of debt include secured and unsecured debt or revolving and installment. Debt categories can also include mortgages, credit card lines of credit, student loans, auto loans, and personal loans. If you are struggling to pay your debt, you may want to consult with a financial advisor to review your options like budgeting, loan consolidation, or bankruptcy.