Welcome to Module 4: Debt Management! In this first lesson, we'll explore the world of debt by understanding the different types of debt that individuals can encounter in their financial lives.
What Is Debt?
Debt is money borrowed from a lender or creditor with the agreement that it will be repaid, typically with interest, over time. While debt can be a valuable financial tool, it's essential to understand the various forms it can take.
1. Secured Debt
Secured debt is backed by collateral, which is an asset that the lender can claim if you fail to repay the debt e.g. land. Common examples of secured debt include:
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Mortgages: Home loans are secured by the property itself.
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Auto Loans: Car loans are secured by the vehicle being financed.
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Secured Personal Loans: Some personal loans require collateral.
Secured debt typically carries lower interest rates because the lender has a way to recover their funds if you default.
2. Unsecured Debt
Unsecured debt, as the name suggests, is not backed by collateral. Lenders rely on your creditworthiness and trust that you'll repay the debt. Common examples include:
Salary Loans: These are loans that are given against your salary. They are backed by the company that employs you.
3. Revolving Debt
Revolving debt is a type of credit that allows you to borrow, repay, and borrow again, up to a credit limit. Credit cards are the most common form of revolving debt. It's essential to manage revolving debt carefully to avoid high-interest charges.
4. Instalment Debt
Installment debt is a fixed loan with a set repayment schedule. You make equal payments over time until the debt is fully repaid. Auto loans and mortgages are examples of installment debt.
5. Good Debt vs. Bad Debt
Debt can be categorized into "good debt" and "bad debt" based on its purpose and potential benefits:
Good Debt: Good debt is used to acquire assets or investments that may appreciate in value or generate income over time. Examples include a mortgage for a home, student loans for education, or a business loan to start a profitable venture.
Bad Debt: Bad debt is incurred for non-essential purchases that don't provide long-term value or generate income. Credit card debt from overspending on discretionary items is a common example.
Understanding the types of debt and distinguishing between good and bad debt is crucial for effective debt management. In the upcoming lessons, we'll explore strategies for managing and reducing debt and delve deeper into the concept of good and bad debt.