What are the main categories of debt?
Most Americans encounter some form of debt at one point in their lives. Debt comes in several forms, but all debt can be categorized within a few main types including secured debt, unsecured debt, revolving debt and mortgages. Not all debts are created equally; therefore, some are considered better than others.
Secured debt is any debt backed by an asset for collateral purposes. A credit check is necessary for the lender to judge how responsibly you handle debt, but the asset is pledged to the lender in case you do not repay the loan. For example, if you require a loan to purchase a car, the lender supplies you with the cash necessary to purchase it but also places a lien, or claim of ownership, on the vehicle's title. In the event you fail to make payments to the lender, it can repossess the car and sell it to recoup the funds. Secured loans like this have a fairly reasonable interest rate, which is based on your creditworthiness and the value of the collateral.
Unsecured debt lacks any collateral. When a lender makes a loan with no asset held as collateral, it does so only on the faith in your ability and promise to repay the loan. Granted, you are still bound by a contractual agreement to repay the funds, so if you default, the lender can sue to reclaim the money owed. Doing so comes at a great cost to the lender, however, so unsecured debt generally comes with a higher interest rate. Some examples of unsecured debt include credit cards, signature loans, gym membership contracts and medical bills.
Revolving debt is an agreement made between a lender and consumer that enables the consumer to borrow an amount up to a maximum limit on a recurring basis. A line of credit and credit card are examples of revolving debt. A credit card has a credit limit, and the consumer is free to spend any amount below the limit until the limit is reached. Payment amounts for revolving debt vary based on the amount of funds currently on loan. Revolving debt can be unsecured, as in the instance of a credit card, or secured, such as on a home equity line of credit.
Mortgages are probably the most common and largest debt many consumers carry. Mortgages are loans made to purchase homes, with the subject real estate serving as collateral on the loan. A mortgage typically has the lowest interest rate of any consumer loan product, and the interest is tax deductible for those who itemize their taxes. Mortgage loans are most commonly issued at 15- or 30-year terms to keep monthly payments affordable for homeowners.