💸😬 All About Debt: Are You In Control?

The guide to end debt.

The Briefcase is a newsletter offering comprehensive, easy-to-follow personal finance guides. Personal finance covers a wide array of topics and the internet is filled with a lot of noise. Use The Briefcase to arm yourself with financial literacy without having to search far and wide for it.

Understanding Debt to Avoid Financial Ruin

Debt occurs when you borrow money from a lender (like a bank) and agree to pay it back over time, typically with interest. Many Americans overspend or don’t know how to budget their money, resulting in excessive debt. Debt can be a useful tool for achieving certain goals, but it can also cause stress and financial insecurity if it gets out of control. Emergencies (like natural disasters, medical problems, pandemics, or unanticipated job loss) can cause you to accumulate debt if you don’t have money set aside for those times.

Not having an emergency fund is an emergency!

Not all debt is ‘bad!’ If you stay on top of it, debt can be a great tool for your future. People take on debt to buy a home, invest in a rental property, go to school to kickstart their career, or start a business, all with the hopes of a return on the investment (like gaining equity in your home or profit from a business or rental property). In these cases, debt can be a positive investment. It’s important to understand the loan terms and repayment so it will pay off for you.

Let’s dig into the different types of debt to gain a better understanding of how it all works.

Secured vs. Unsecured Debt

Secured debt is backed by collateral, like a mortgage or a car loan. If you default (stop paying) on the loan, the lender can repossess the collateral to recoup their losses. Secured loans often have low interest rates because the lender has a low risk of losing money.¹ Unsecured debt isn’t backed by collateral and includes credit cards, personal loans, and medical bills. If you don’t repay the debt, the lender can’t seize any of your assets to cover the outstanding balance. Since the lender takes on a high risk of loss, interest rates will typically be higher.

Source: OpenMoney

Revolving vs. Installment Debt

Revolving debt is like a credit card - it’s constantly available to you, and as long as you’re staying within your credit limit, you can continue to borrow up to that limit (so long as you pay it back). This can get out of control quickly if unmanaged! Installment debt is usually for large purchases, such as a house or car, and thus you’ll have a set number of ‘debt installments’ to pay back. The main takeaway is that revolving debt is easy to get carried away with - so when it comes to a credit card, you must keep your spending in check. Installment debt makes it easier to budget for because you’ll always know what you’re paying (think about fixed expenses that are the same each time, like rent). It’s good to know the difference between the two, but focusing sharply on revolving debt will keep your spending habits tight.

Source: Cash 1 Loans

Consumer vs. Business Debt

Consumer debt is for personal use; think credit cards, car loans, student loans, and mortgages. You pay back these loans back from your personal income, and your property could be taken if you don’t pay (depending on your loan terms). Business debt is used by companies for business expenses, like purchasing inventory, equipment, or expanding. This can be a great investment if you can grow your business and increase profits!

The key difference is that business debt is repaid using your company's income, and the business is collateral. If you can’t repay your business debt, you can lose your business. Unless you have your own business, you won’t have to worry about this, but it is still important to understand the basics.

Consequences of Excessive Debt