Most Common Types of Debt

There are two types of debt: secured debt, which in effect means that the lender or creditor is entitled to reclaim the collateral in the event of a default in loan repayments; and unsecured debt, which is not secured on a specific piece of property. Typical examples of secured debt are secured on homes (mortgages), on cars and on boats. Unsecured debts are most commonly credit cards, store cards, cell phone bills, and any remaining outstanding debt owed to a lender after repossession or foreclosure. Although these debts began as secured debts, they become unsecured once the bank has repossessed the property.

Revolving Debt vs. Installment

Creditors further categorize debt into revolving or installment debt. For example an installment debt may be for payments made on a house or car. This means that the amount of the debt is fixed and is payable monthly. A revolving debt is a debt for which the payments change on a monthly basis. For example, the balance outstanding on a credit card will change monthly depending on repayments, new transactions, interest and other charges.

Good Debt?

You may hear people talking about good debt and bad debt, which can sound strange given that you might consider that all debt is bad debt. Broadly speaking debt is good if it is used to invest in something that is appreciating in value at a greater level than the cost of the credit. For example, if you bought a property cheaply with a mortgage and the cost of the mortgage was less than the increase in value of the property this could be classed as good debt. Similarly, purchasing a car using credit is arguably a good debt because although it depreciates in value it is still an ‘investment.' Although the majority of the proceeds of a student loan is probably not spent on investment items, it is still considered an investment: education improves an individual's future employment prospects.

Bad debt however is debt incurred for goods or services that are decreasing in value, or by their nature are no longer valuable. For example if you sold clothes and shoes that you had bought on credit they would not fetch as much money as you paid for them. As such they are not an ‘investment'. Another example of bad debt would be paying for a vacation using a credit card, and then taking a long time to pay it off. Not only is the vacation something that is irredeemable once you're back home, but the cost of the debt is likely to be expensive too. Payday loans and loans from pawn shops have even higher interest rates than credit and store cards, and should be avoided if at all possible.

It should be noted however that in order to achieve a good credit score it is advisable to have a mixture of secured and unsecured credit, all of which must of course be well maintained.

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