What is Debt?
Debt refers to an amount of money borrowed by one party from another. It typically involves a borrower who owes money to a lender. While the terms “loan” and “debt” are often used interchangeably, a loan is a specific type of debt with defined repayment terms.
Common Forms of Debt
- Loans
- Mortgages
- Credit Card Debt
- Personal Loans
Types of Debt
1. Secured Debt
Secured debt is backed by collateral, such as a car, home, jewelry, National Savings Certificates (NSCs), or LIC policies. If the borrower fails to repay the loan, the lender can seize the collateral to recover losses. [Read our detailed article on “What is Debt Repayment?“]
2. Unsecured Debt
Unsecured debt does not require collateral. Examples include personal loans and credit card debt. Lenders assess the borrower’s creditworthiness to determine eligibility and interest rates.
3. Revolving Debt
Revolving debt allows the borrower to borrow and repay funds repeatedly up to a set credit limit. Credit cards are a common example. Once the previous debt is repaid, the credit becomes available again. A strong repayment record can also lead to an increased credit limit.
4. Installment Debt
Installment debt involves borrowing a fixed amount and repaying it in equal payments over a specific period. Mortgages and car loans are typical examples.
5. Financing Debt
Financing debt refers to money borrowed by companies for business expansion. This can include large bank loans or the issuance of bonds for major capital expenditures.
Specialized Types of Debt
Mortgage
A mortgage is a secured loan used to purchase real estate. The property itself serves as collateral. Mortgage approval depends on the borrower’s credit score, which varies based on loan type and amount. Mortgage terms often range from 15 to 30 years.
Corporate Debt
Corporate debt arises when companies borrow funds for business operations. Bonds are a common instrument for raising corporate debt. Companies issue bonds to investors, promising regular interest payments and the return of the bond’s face value at maturity.
Pros and Cons of Debt
Advantages
- Facilitates business financing when capital is limited
- Supports business expansion
- Enables significant purchases (e.g., homes, vehicles)
- Reduces tax obligations
- Serves as a legal and structured financing method
Disadvantages
- Increases the risk of insolvency
- Involves interest payments, which can be substantial
- May put personal assets at risk for secured debts
- Limits the ability to take on new debts until existing ones are repaid
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