All About Debt: Types of Debt
Taking on debt is a big decision, one that can either serve a student's financial future or seriously hinder it. Understanding what kinds of debt a student may take on is essential for them to properly plan and secure their future.
By Paul Merimee — March 6, 2023
Debt is an incurred obligation to return a borrowed item, usually with fees or terms included. For example, someone borrows their neighbor's car for a weekend and agrees to fill the tank before returning the car. The most common type of debt occurs with money, in which the associated fees or terms occur in the form of interest. In finance, there is rarely a debt that requires only paying back the initial sum; however, there are several types of debt, each with its own set of terms, conditions, and implications. Understanding the types of debt is the first step to making informed decisions regarding debt and financial well-being.
Secured vs. Unsecured Debt
Secured Debt:
This type of debt is associated with a collateral, which can be a house, a car, or even expensive jewelry. The purpose of the collateral "secures" the loan, meaning if the debt is not paid off as agreed the collateral can legally be seized to make up the difference in amount owed. Good examples of secured debt include mortgages, where the property itself is used as collateral, and car loans, where the car serves as the collateral. With these debts, risk to the borrower is greater as they can lose high-value items with little to no recourse while risk to the lender is low. The benefits can include lower interest rates and higher amounts available to borrow. Students usually do not have access to secured loans, unless they choose to get a car loan, so the category of debt they will typically fall into is "unsecured debt."Unsecured Debt:
This type of debt is not associated with collateral, so to ensure the borrower is trustworthy, the borrower's credit score acts as their "backing," which lets the lender know how likely they are to be repaid. Examples of unsecured debt include student loans, medical bills, and credit card debts. Since the risk to the lender is greater with unsecured debt, the interest rates tend to be higher. However, since collateral is not needed, people without collateral can borrow more easily, allowing them more financial flexibility should they need it. While the lack of collateral may sound enticing, students need to be aware of the downsides of high-interest rates. With unsecured loans, the amount of debt can quickly and exponentially grow, and if a student lacks the means to pay off that debt, they can find themselves financially crippled for years to come.Revolving vs. Non-Revolving Debt
Revolving Debt:
This kind of debt can either be secured, like a home equity line of credit or unsecured, like a credit card. Essentially, the borrower has a limit on what they can borrow and must repay what they borrow within a set time period. Every payment made against the debt increases the amount available to borrow. When money is used, the availability decreases until repayment and so on and so forth. When payments are consistent, and in full the limit may increase. Students will encounter this primarily in the form of credit cards. Having multiple open credit lines may make it more difficult for a student to keep track of everything.Non-Revolving Debt:
These loans are given out in one installment and must be repaid over a set time period. Unlike revolving debt, the money is all used upon borrowing so there is no cyclic movement of money. These can be secured, like a mortgage, or unsecured, like a student loan. It is important to have a long-term plan and make payments on a consistent schedule to pay off the debt promptly. Student loans are the most obvious form of non-revolving debt; however, medical bills are another important one to be aware of, as these can be unexpected and rather painful (financially and physically).Types of Student Loans
Direct Subsidized Loans (Unsecured, Non-Revolving Debt)
- If an undergraduate demonstrates financial need they can qualify for this type of loan. The major benefit of these loans is that the government will pay the interest during certain, set periods like while the student is attending school, for the first six months after school, or during education deferment periods and students do not have to repay the loans during these periods. Students can qualify for deferment if they are in school, undergoing cancer treatment, unemployed, in the military, and more. Check out this link for more information. These loans also tend to have low interest rates.Direct Unsubsidized Loans (Unsecured, Non-Revolving Debt)
- Unsubsidized loans do not require proof of financial need. This means that almost anyone can qualify for them but they contain several key caveats. Namely, interest will accrue while the student is enrolled. The student does not have to pay off the loan while in school or during the six-month grace period, however, interest is still accruing and by the time they do go to pay back their loans they may find themselves in significant debt. The interest rates on these loans are also higher. For both subsidized and unsubsidized loans, the borrowing limit is set at $31,000 (dependent) and $57,000 (independent). As an example, if the unsubsidized loan is set at 4.3% interest per year and the student borrows the max amount for an independent student, by the end of four years they will have accrued roughly $10,453 in interest. This translates to a total student debt of $67,453.Taking on debt is a big decision, one that can either serve a student's financial future or seriously hinder it. Understanding what kinds of debt a student may take on is essential for them to properly plan and secure their future. In the next article some of the dangers of debt will be outlined as well as some strategies for combating and preventing excess debt.
Paul Merimee
Paul Merimee grew up in sunny and vibrant Cleveland, Ohio with his eight siblings. In his early years Paul loved to read, voraciously consuming anything that had an engaging front cover at the library. Paul wanted to be a software engineer, not an author. He somehow ended up going to a small, liberal arts college in the middle of Wyoming. It was there that he was introduced to the great writers like Homer, Dostoevsky, Aristotle, and more.
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