Image: Unsplash
Image: Unsplash

Fundamentals of Finance: What is debt?

I’m sure we have all heard of the word ‘debt’. More often than not it is used in a negative context. But what exactly does it mean?

In simple words, debt is when a party borrows money from another party; usually a bank. When money is borrowed, it is often referred to as a loan. People borrow money for a range of reasons but usually it is to pay for something that they would not be able to afford without the borrowed money. When one wishes to take out a loan from a bank, they must sign a credit agreement. This is a legally binding contract in which all the terms and conditions of the loan are explained. This usually includes information regarding how much interest will be added onto the loan as well as the time frame by which the loan needs to be paid back by.

People borrow money for a range of reasons but usually it is to pay for something that they would not be able to afford without the borrowed money

There are many different types of debt with mortgages being one of the most common and well known types. A mortgage is when the loan is used to purchase real estate such as a house. There are many different types of mortgages including fixed rate and adjustable rate mortgages. However, one key difference when compared to other types of debt is the duration. Mortgages are usually repaid over 30 years.

Another popular type of debt is consumer debt, an example of this is credit card debt. Credit cards enable you to loan a certain amount of money, usually from a bank. When used carefully, credit cards can help to boost your credit score. Most people who pay off their credit cards every month have no issues with this type of debt. However, the problem begins when you can’t keep up with re-payments. If you miss payments, banks will often charge you late fees. This combined with interest can begin to snowball and leave you in heaps of debt. This is why it is very important to make sure you don’t spend more on your credit card than you can afford to pay back.

It is worth remembering that not all debt is acquired by loaning money from the bank. If you ask to borrow some money from your friends or family, you are in debt to them. The difference is that banks will make you sign an agreement with details of penalties if you do not pay on time whereas a lot of family would not.

Another way people sometimes get into debt is by failing to keep up with ongoing payments. For example if they accumulate rent arrears or debt for unpaid utility bills. These types of debt are very serious as you may be at risk of losing your home/having your energy cut off if you do not work out a payment plan.

There are many different types of debt and being in debt is not always a bad thing. If you are struggling with debts, it is worth seeking advice before things get out of hand

A debt which most students will have is student loan debt. This works very differently to most other debts as a small percentage is deducted from your salary before you have access to it. Also unlike other debts, you are only eligible to repay the debt if you earn over a certain threshold. If you haven’t paid off the debt in 30 years it will simply be written off.

To conclude, there are many different types of debt and being in debt is not always a bad thing. If you are struggling with debts, it is worth seeking advice before things get out of hand. Most organisations are reasonable and can work with you to set up a suitable payment plan.

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