What are the main categories of debt?
Most Americans encounter some form of debt in their lives. However, not all debts are created equally and some are considered better than others. Indeed, while debt comes in several forms, all personal debt (not corporate or government debt) can be categorized within a few main types, including secured debt, unsecured debt, revolving debt, and mortgages.
Secured Debt
Secured debt is any debt backed by an asset for collateral purposes. A credit check is necessary for the lender to judge how responsibly debt has been handled in the past, but 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.
Key Takeaways
- The main types of personal debt are secured debt, unsecured debt, revolving debt, and mortgages.
- Secured debt requires some form of 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.
- Mortgages are home loans that typically have 15- or 30-year terms, with the real estate serving as collateral.
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. In the event the car buyer fails to make payments, the lender can repossess the car and sell it to recoup the funds. Secured loans like this have a fairly reasonable interest rate, which is generally based on creditworthiness and the value of the collateral.
Unsecured Debt
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 the borrower’s ability and promise to repay the loan. 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, and, for this reason, 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
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 or a 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
Mortgages are the most common and largest debt many consumers carry. Mortgages are loans made to purchase homes, with the subject real estate serving as collateral. A mortgage typically has the lowest interest rate of any consumer loan product, and the interest is often 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.
