The Different Types of Debt

In the world of personal finance, debt may not have the greatest reputation - and rightly so. Debt often hinders us from achieving our financial goals and for many, it’s a burden we want to get rid of (and fast!).

We’ve probably all seen an inspirational story somewhere about someone paying off their debt, and whilst paying off debt and its importance is spoken about a lot, there aren’t many conversations surrounding the different types of debt. 

Definitions and feelings surrounding debt may vary from person to person, it’s important to be able to understand and identify different types of debt and repayment strategies so we know what we are getting ourselves into. 

So, buckle up for our guide to understanding debt!

What is debt?

To put it simply, debt is when you owe someone money. Anything that you didn’t pay for in full or borrowed from someone else, whether it’s someone you know personally or a bank, it’s something that you are expected to pay back.

There are two broad categories of personal debt:

Secured debt 

With secured debt, the money that you borrow is secured against a physical item. Take car finance or house mortgages, for example, you’re borrowing money that is secured against that physical item.

Generally speaking, secured debt is offered with a lower interest rate due to the lender’s security of collateral lowering their risk. This is because if you were to miss payments, the lender would be able to repossess the items to finance is secured against. However, interest rates are also subject to an individual’s financial health and risk profile.

Unsecured debt

Unsecured debt is the money that you borrow that doesn’t have any physical item tied to it, instead, it’s based on your financial capacity such as your earnings and risk profile (your credit score provides lenders with a perceived level of risk you have e.g. the likelihood you will meet your commitment of repayments). 

Examples of these are credit cards, bank overdrafts and some loans. Lenders deem unsecured debt riskier than secured debt because their money isn’t backed by collateral, so they tend to have higher interest rates and offer lower levels of borrowing to accommodate this risk (that explains the ridiculously high interest on credit cards!).

There are two main types of repayment strategies for personal debt:

Revolving debt

Revolving debt is when you borrow a set amount on a recurring basis. Think of it as a borrowing cycle where you can borrow the money, repay it, borrow again, and so on…

Examples of these are credit cards and bank overdrafts, but because of their high-interest rates, they should be handled with care as they can spiral out of control if you miss or only make the minimum payments, along with additional fees if you go over your agreed limit. For example, if you only pay the minimum monthly payment on a credit card, it can take you over 28 years to pay off the money you owe and the accumulated interest over that time.

Non-revolving debt

Non-revolving debt is where you borrow a set amount of money and can pay it back in regular instalments over a set period. Once you’ve completed the repayments, the credit agreement is finished. Examples of non-revolving debt are car loans and house mortgages.

When considering this type of borrowing, always look at the total amount you will pay over the length of the agreement rather than just how much it costs per month. What seems like a small monthly repayment could total to a very expensive amount of borrowing.

So, there you have it, the main types of debt and repayment strategies! Knowing this will help you identify the different types of debt and understand some of the different repayment strategies.

For more insight into debt, stay tuned on our blog where we will be covering more need-to-know insights, from understanding debt to getting rid of it!

The following is for general information and is not intended as a form of financial advice by Finndon or its representatives, nor the information intended to be relied upon by individuals in making any financial decisions.