A Debt Overview: Getting to Know the Money You Owe

According to recent reports, the typical American household carries more debt than ever. With $16.9 trillion in consumer debt as of the fourth quarter of 2022, experts warn that high debt levels could lead to increased delinquencies and defaults. In particular, credit card debt could hit a record high of $986 billion. This trend could continue as inflation rates rise.

It's more important than ever for individuals to manage their debts responsibly and avoid taking on more than they can handle. From creating a budget to paying bills on time and avoiding unnecessary purchases, there are steps everyone can take to get their debt under control.

In this article, we'll provide an overview of the different types of debt and offer strategies for repaying them. Whether you're dealing with credit card debt, student loans, or other types of debt, our goal is to help you develop a plan for getting back on track and achieving financial stability.

Four Types of Debt

When it comes to managing debt, it's important to understand the different types of debt and how they work. There are four main types of debt that you're likely to encounter: secured debt, unsecured debt, revolving debt, and installment debt. Each type of debt has unique features and repayment strategies. Understanding these differences is essential to developing a plan for paying off your debts.

In this section, we'll provide an overview of each type of debt, so you can better understand what you're dealing with and how best to tackle it. It is worth mentioning here that a debt can fit more than one category. For example, a car loan is both a secured and installment debt.

Secured Debt

Secured debt is a type of debt that is secured by collateral, which is something of value that you own and pledge as security for the loan. The lender can repossess this collateral if you default on the loan, which reduces the lender's risk and makes it easier to qualify for the loan. Common examples of secured debt include mortgages, auto loans, and secured credit cards.

Advantages of Secured Debt

One advantage of secured debt is that it typically has lower interest rates than unsecured debt. The collateral reduces the lender's risk. So they feel free to charge less.

A second potential advantage is that secured loans can give you access to more significant amounts. An auto loan, for example, is secured by the vehicle itself, so you can get $30,000 to buy a Ford, even if a bank would not lend you the same amount of money without collateral.

Relatively, longer terms are also standard with many forms of secured debt. If we return to the auto loan example, it is common to find repayment terms of 60 or 72 months.

Secured debt can also help you build credit if you make timely payments.

Let's recap those four potential advantages of secured debt.

• Low interest,
• Large loan amounts,
• Long repayment terms,
• It can build credit.

Disadvantages of Secured Debt

There is a big fat disadvantage too.

With secured debt is the risk of losing your collateral if you default on the loan. This can be particularly problematic if you've borrowed more than the collateral is worth, as you'll still owe the difference.

If we once again think about a car loan, you may have heard about someone who had a car repossessed or wrecked and who still had to make payments.

There are often limited options for the collateral. With the possible exceptions of pawn shop loans, which the team here at You, Money, Happiness strongly discourages, there are relatively few types of collateral a lender will find acceptable.

Secured loans can also harm your credit score if you pay late or miss payment altogether. Once again, let's summarize. We pointed out three disadvantages of secured debt.

• Collateral loss,
• Limited collateral options,
• It can harm credit.

Repayment Strategies for Secured Debt

When repaying secured debt, the key is to make your payments on time to avoid defaulting and losing your collateral.

It's also important to prioritize paying off higher-interest loans first, as they can cost you more in the long run. If you struggle to keep up with your payments, consider refinancing the loan or negotiating a payment plan with the lender.

In some cases, you may also be able to sell the collateral to pay off the debt. Whatever you do, please don't ignore your secured debt, as it can have severe consequences for your credit and financial well-being.

Unsecured Debt

Unsecured debt is not secured by collateral, meaning that the lender takes on more risk by lending money without the guarantee of repayment. Common examples of unsecured debt include credit cards, personal loans, and medical bills.

Advantages of Unsecured Debt

One advantage of unsecured debt is that you don't have to put up collateral to qualify for the loan. This can make it easier to access credit if you don't have valuable assets to use as collateral.

Another advantage is that there are typically no restrictions on how you use the money, unlike some secured loans where the funds can only be used for specific purposes (such as buying a car or a house).

Compared to other forms of debt, unsecured loans typically have a faster approval process because there is no need for an appraisal or other assessments of collateral.

Finally, you will find a common theme, and that is that debt can have a positive impact on your credit score if you pay on time and without issue.

Let's recap the potential advantages of unsecured debt.

• No collateral is required,
• No restrictions on how to spend the loan,
• A short approval process,
• It can build credit.

Disadvantages of Unsecured Debt

One significant disadvantage of unsecured debt is that it usually comes with higher interest rates than secured debt. This is because the lender is taking on more risk by lending money without collateral.

In fact, some experts put payday loans, which have ridiculously high interest rates, into this category, and we hate payday loans here at You, Money, Happiness. Taking out a payday loan is "A Descent into Debt with the Devil."

Another disadvantage is that there are typically lower borrowing limits for unsecured debt than for secured debt, so you may not be able to borrow as much as you need.

Unsecured debt can also be more challenging to qualify for, especially if you have a limited credit history or a low credit score. Lenders may require proof of income, employment, or other financial information to assess your creditworthiness.

Unsecured debt often has short repayment periods compared to other forms of debt. For example, a loan might need to be repaid in a year or less.

Finally, like every other form of debt on this list, not paying will impact your credit score negatively.

So let's revisit the disadvantages of using unsecured debt.

• High interest,
• Small loan amounts,
• More qualifications,
• Short repayment terms,
• I can harm credit.

Repayment Strategies for Unsecured Debt

When repaying unsecured debt, making your payments on time is essential to avoid late fees and damage to your credit score. One effective strategy mentioned in the section above is to first pay off high-interest debt, such as credit cards or personal loans with high APRs.

We are also a fan of developing a side hustle to generate extra income and focus that new-found income on debt reduction.

Revolving Debt

Revolving debt is a type of debt that does not have a fixed repayment schedule or end date. Instead, you're given a credit limit that you can use to make purchases or withdraw cash as needed, and you must make a minimum payment each month. Common examples of revolving debt include credit cards and lines of credit.

Advantages of Revolving Debt

One advantage of revolving debt is the flexibility it provides. You can use the credit limit as needed, and you only have to make a minimum payment each month, which can be helpful if you have irregular income or unexpected expenses.

It provides effortless access to credit too. As mentioned at the beginning of this section, revolving credit can be used when you need it.

Another advantage is that revolving debt can be a helpful tool for building credit. If you make your payments on time and don't have a high balance, your credit score may improve.

So, to summarize, the advantages of using revolving debt include:

• Repayment flexibility,
• Easy access to funds,
• It can build credit.

Disadvantages of Revolving Debt

One significant disadvantage of revolving debt is the high-interest rates that often accompany it. Suppose you only make the minimum payment each month. In that case, the interest charges can quickly add up, making it difficult to pay off the debt.

There is also a temptation to overspend. The credit is just so easy to use; why wait. This credit trap has pulled some households down into the debt abyss.

Let's double down on this point. If not used responsibly, revolving debt can lead to a cycle of increasing debt known as a "debt spiral" or "debt hell." As interest charges accrue on unpaid balances over time, borrowers may struggle to keep up with their payments and fall deeper into debt.

As you can imagine, falling into a debt spiral destroys your credit score too.

So the disadvantages of using revolving debt include the following:

• High interest,
• The temptation to overspend,
• It can harm credit.

Repayment Strategies for Revolving Debt

Making more than the minimum monthly payment is essential when repaying revolving debt. This single tactic can help you pay off revolving debt more quickly and reduce the interest you'll pay over time.

Other specific repayment strategies can help too. The "debt snowball" method focuses on paying off the smallest balances first, then working up to larger ones. Another strategy is the "debt avalanche" method, where you first focus on paying off the debts with the highest interest rates.

Installment Debt

An installment debt has a fixed repayment schedule, meaning you must make regular payments (usually monthly) until the loan is paid off. Common examples of installment debt include car loans, student loans, and mortgages. Notice that installment debt can be either secured or unsecured.

Advantages of Installment Debt

One advantage of installment debt is the predictability it provides. With a fixed repayment schedule, you know exactly how much you must pay each month, making budgeting easier.

Installment debt often provides access to more significant amounts of money than, for example, revolving debt. What's more, installment loans often have relatively lower interest rates than revolving debt.

Another advantage is that installment debt can be a valuable tool for building credit. As long as you make your payments on time, your credit score may improve, making it easier to qualify for other types of loans or credit in the future.

Let's review the advantages of using installment debt compared to revolving debt.

• Predictable payments,
• Access to large amounts,
• Low-interest rates,
• It can build credit.

Disadvantages of Installment Debt

One disadvantage of installment debt is that it can be more challenging to qualify for compared to other types of debt, especially if you have a limited credit history or a low credit score.

Depending on the lender and the type of loan, you may need to put up collateral (such as your home or car) to secure an installment loan. This can be risky if you're unable to make your payments.

Once you've taken out an installment debt, you're committed to making regular payments for the loan term. If your financial situation changes, it may be challenging to adjust your payment schedule. This is a lack of flexibility compared to other debt options.

And, you guessed it, not making the regular payment can harm your credit score.

Let's summarize the potential disadvantages of using installment debt.

• More qualifications,
• It may require collateral,
• Little flexibility,
• It can harm credit.

Repayment Strategies for Installment Debt

When repaying installment debt, making your payments on time is essential to avoid late fees and damage to your credit score. One effective strategy is to focus on paying off the loan as quickly as possible, which can help you save on interest charges and reduce the overall cost of the loan.