A loan can be a great tool, but a dangerous enemy! It’s a huge decision that everyone should think through properly.
Of course a loan can help you in various ways, like becoming a homeowner — instead of paying rent to a stranger, you’re gaining your own place. It can also help you start your own business, if that’s what you dreamed of since you can remember. It can also be a life-saver in case anything happens: but your emergency fund should be a number one safety net.
However, debt is associated with numerous difficult life situations. Did you know that it’s a common enemy for more than 80% of Americans? People with lower incomes are sometimes forced to take on debt, often falling into a debt spiral. Having a bad credit history can mean getting the worst deals and getting out of this situation can be hell. Use loans as a good servant, and never borrow money for vacations or consumer goods!
What is debt? 👀
Debt is basically borrowed money that lets you make larger purchases than you normally could. The borrowed money is paid back later in the future, but with extra fees. Even though this is something we usually know, there is much more behind the curtain to understand — and the topic gets complex quickly. Today, we will explain basic terms that you can stumble across regarding types of debt and its management.
Let’s talk about different loans 💰
Need to borrow money? First, you need to determine which loan is the most suitable for your personal situation. Here are some common debt types:
Mortgage 🏡
If you’re buying or refinancing a property, this is the type of loan for you. Home is one of the most valuable assets for the majority of people, that’s why they decide to go for this long-term loan. The average loan repayment period is 25 years, but the repayment can take much longer. Mortgages aren’t easy to get, in fact, they are very dependent on your personal factors, such as credit score, assets or type of employment. Depending where you live, there might be different laws regarding your attainable mortgage value, your maximal monthly payments, your minimal down payment and you should also look into what property it might be leveraged with.
Delayed Payment 🐢
If you know how to use delayed payment services correctly, it can be to your advantage! There are many online payment services that enable you to receive your ordered goods and pay for them later (usually up to a month). This can be handy for example when you have unexpected expenses and can’t wait until your next salary. However, we always recommend having an Emergency Fund ready for cases like this, so you don’t have to immediately take a loan when something goes wrong.
Credit Card 💳
Credit card is an item that lets you pay with the lender’s money. The interest rate and credit limit is set by the owner of the money! There usually is a period that allows you to repay the debt without an interest on top. It’s usually pretty high, so don’t forget to double-check that you’ll be able to pay it back in time. It’s a good system, but it can get out of hand if used regularly without proper management and finances. Before starting a shopping spree, you should definitely be aware of the pros and cons: as credit cards tend to support overspending and lead to more debt if handled irresponsibly. On the other hand, they help you build your credit score & are a safety net for emergency costs.
Business Loan 💼
It’s important to recognize that not all debt is bad: in fact, without it a lot of great opportunities for expansion and innovation can be missed. For example, you can start your own business! If you’re self-employed and get a business loan, you can make extra money and repay the debt. It can be very beneficial, but keep in mind that there is always a risk of ending up with a failed business and a debt to pay.
Student Loan 🎓
Student loans are usually used to pay for higher education, such as university or college. The average public university student in the States has to borrow $30,030 to get a bachelor’s degree. This has to be paid back with interest, unlike scholarships or grants. A 2019 study showed that it took an average of 18.5 years to repay a student loan for more than 2000 recipients! Even though these numbers are scary, getting a degree opens many possibilities to better employment and salary.
Leasing 🧩
Leasing comes in many types, but the most common one is renting assets (eg. car) owned by the leasing company. If you need a car, there is an option to pay leasing instead of buying it with your own money! At the end of this period, the car will remain owned by the leasing company or you can keep it if you pay the residual value of the car to the leasing company. Even though you don’t own the car during the leasing period, it can be a good way to finance your assets!
And what are the must-knows? 👀
To help you navigate in this topic, we prepared a list of some commonly used expressions:
Credit Score 💳
Credit history is what builds one’s credit score, and it consists of various factors: debt, account type, age of accounts and even late payments. It should be a reflection of your responsibility in debt repayment. The aim is to get a higher score, since it makes you look better in the eyes of potential lenders! Credit score system works only in some countries, but often there is an equivalent like a debtors register.
Interest 📈
When borrowing money from any party, repaying the principal sum isn’t enough. Interest rate is a percentage that is charged from the total amount of the loan. This is how the lender makes money — by charging you an interest on top of what you repay. Predatory lenders exist with very high interest that prey on desperate people with low credit scores that need money and can’t get a loan elsewhere, so watch out and make sure you only borrow from reputable sources!
Liability 💸
Liabilities are a responsibility not yet paid: such as bank debt, mortgage debt, owned taxes or even some invoices As you can see, liability is a broader term and debt is only one of the types.
Consolidation 💰
Debt consolidation allows you to merge different kinds of debt into one monthly payment. If you’re handling numerous loan repayments each month, this might be something to look into. When you consolidate multiple loans into one, you can often get new terms like lower interest rate or lower monthly repayments, so this could be a good first step to get out of debt!
Refinancing 💰
Debt refinancing is similar to debt consolidation, but it is more suitable, if you’re planning to only replace a single debt with more favourable terms like a lower interest rate or smaller monthly repayments.
Bankruptcy 🤯
Bankruptcy is a legal procedure that allows to solve debt by insolvency. An individual is declared bankrupt if conditions are unlikely to get better and there is only little hope of repaying the debt. Be aware that all of the things you own need to be evaluated and can be used to repay debt and even then you might not be completely free of your debts! After filing bankruptcy, it is usually not possible to get credit for a bigger amount of money or apply for a loan. The key to maintaining good financial management after bankruptcy is rebuilding your credit score & using your income very wisely!
Repayments 💸
Periodic installments that are used to return the borrowed money to the lender. A key to good financial health is understanding how your debt repayment works and having a plan. The repayment period may vary depending on your loan, usually a mortgage is dozens of years, while a car loan can be repaid in a few years.
Principal 🤑
The primary money you borrow at the beginning is a principal. The overall debt therefore consists of the principal plus the interest that accumulated on the principal.
Debt Elimination ❌
Debt elimination programs are structured to help you pay off debts easier, without huge negative effects on your credit score or personal finance management.
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