What You Need to Know About Different Types of Debt
If you’re impacted by debt, it might feel like enough to just know the amounts you owe. And while, that’s important, it’s only a small part of the picture. There are actually different types of debts, and not all are created equally. The different classifications of debt can impact your credit score differently, determine how you prioritize repaying each one and can impact how you borrow money in the future. Having a better understanding of each type can help you avoid future financial distress. Debts can be categorized as either secured or unsecured debt. From there, your secured and unsecured debts are either revolving or installment debts.
Unsecured debt vs. Secured debt
The first component to knowing the different classifications is to know whether debt is secured or unsecured. Here’s the difference.
An unsecured debt means lenders do not have rights to any collateral for debts owed. If you fall behind on any payments, a lender generally cannot seize any of your assets However, lenders can hire a debt collector, and if that tactic is unsuccessful they can take further action, including putting a lien on your assets or garnishing you wages. Types of unsecured debts include credit card debt, student loans, unsecured installment loans, payday loans, medical bills and court-ordered child support.
Secured debts are tied to an asset considered collateral for the debt owed. Lenders have rights to seize the asset or put a lien on it if you continue to fall behind on payments. If your assets are seized, they will be sold to pay the debt. If the selling price doesn’t cover the debt, your lender will look to you to make up the difference. Mortgages and auto loans are both examples of a secured debt.
Installment debt vs. Revolving debt
Another way to categorize debt is by how it’s repaid. If a debt does not have a fixed payment amount each month, it’s a revolving debt. If you borrow a fixed sum of money and pay the same amount every month, it’s an installment debt.
Credit card debt (an unsecured debt) is the most common type of revolving debt. With this type of debt, you can keep borrowing money until you reach your credit limit. Because you have the option to pay the full balance or make a minimum payment, this type of debt can be tricky. If you don’t pay the full balance each month, you will owe interest in addition to the principal amount. Plus, interest compounds, so the longer you wait, the more interest you’ll have to pay. With average annual percentage rates (APR) at more than 16%, revolving debt can get out of hand quickly.
Typically, installment debts are student loans, mortgages, auto loans, personal loans and consolidation loans. Installment debts can be secured debts (mortgages, auto loans) or unsecured debts (student loans, medical debts). Installment debts have predetermined end dates and provide a set payment schedule.
Managing different types of debts
Second to knowing how these types of debt work is knowing how each one can impact your finances. Revolving debts and installment debts can both impact your credit score. However, debt from credit cards can be more significant because it can indicate your risk as a borrower, whereas installment loans can be considered more stable and therefore have less influence than revolving debt. With that in mind, paying off revolving debts should be considered more of a priority. Their negative impact on your credit is typically greater, and they have higher interest rates. Also, if you have secured and unsecured loans, you should pay off the secured loans first to protect your assets.
Revolving debt and installment debt can go hand in hand
One strategy to pay off credit card debt can be to take out a personal loan or consolidation loan. Then, you can look forward to a fixed payoff date and automatic monthly payments on just one account.
For more information on different types of debt and how to manage them, visit www.newcreditamerica.com or call us at (877) 373-2330.