Understanding Debt

Almost everyone will encounter some form of debt in their lives, however, not all debts are created equal. The type of debt you take on, along with its quantity and cost, can mean the difference between good debt and bad debt, all of which can be categorized into a few main categories including secured debt, unsecured debt, revolving debt, and mortgages. 

Good vs. Bad: 

Good debt, generally speaking, is low-interest debt that helps you to increase your income. An auto loan or mortgage on an investment property are excellent examples of good debt. Bad debts are just the opposite; they are expensive debts that drag down your financial situation. Examples include debts with high or variable interest rates, especially when used for discretionary expenses or things that lose value. It is important to note, however, that too much of any kind of debt can turn it into bad debt and while you may think that a debt is debt, different kinds of loans and other debts have their own payment plans, tax implications, and overall impacts on your credit scores. 

Debt Categories: 

- Secured Debt: Secured debt is any debt backed by an asset for collateral purposes, and typically has a reasonable interest rate. A credit check is necessary for the lender to determine the borrower's previous financial responsibility. Regardless of the credit report, the asset is pledged to the lender in case the borrower defaults on their loan. An auto loan is an example of a secured debt. A lender supplies you with the cash

necessary to purchase it but also places a 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. 

- 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. An example of unsecured debt includes credit cards, signature loans, gym membership contracts, and medical bills. 

Student Loans: While student loans fall under the unsecured category, they are not treated the same way when it comes to nonpayment. Failure to pay any debt will result in some type of collection effort by the creditor. Since there is no collateral or other guarantor attached to an unsecured student loan, failure to pay will require legal action that can ultimately result in a lawsuit and the possibility of having a judgment rendered against the consumer, including garnishment of wages. 

- 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 either unsecured or secure. Unsecured, as in the instance of a credit card, or secured, such as on a home equity line of credit. 

- Mortgage: Mortgages are the most common and largest debt many consumers carry. Mortgages are loans made to purchase homes, providing real estate serving as collateral. A mortgage typically has the lowest interest rate of any consumer loan and is commonly issued at a (15-30) year term to keep monthly payments affordable for homeowners. 

Regardless of the types or the amount of debt you carry, the most important thing you can do is to keep up with your payments each month and continue to move forward with your financial plan. At Fort Worth City Credit Union, we are committed to the long-term financial success of our members and have partnered with GreenPath Financial Wellness to provide you with access to free, one-on-one counseling, debt management services, and financial education tools. Visit GreenPath Financial Wellness to get started on your path to financial wellness today.