Types of Debt

Most of us take on debt in one form or another - mortgages, student loans, and credit cards to name a few.  Not all debt is created equal, and it comes in many different “sizes” or types so it’s important to know the difference between them, how they work, and how each affects your finances and credit history.   

Below, we break down the different types of debt and some important details that pertain to each of them.  

Secured  

This type of debt is backed by some form of collateral or asset – like a house or car – that you, the borrower, are willing to use to obtain the loan. The collateral is then tied to the loan until it is paid in full and could be taken or repossessed if payments are not made as agreed.  

Having collateral that is valuable can make a borrower seem less risky to a lender and is used as a factor in determining the interest rates and terms offered. Secured loans and credit lines typically offer better rates and terms than other types of debt. Lenders like to see that you are willing to risk something of value to you to secure the loan and may be more willing to lend to you if you do.  

Unsecured  

Just the opposite of secured debt, unsecured debt like credit cards, student loans and personal loans do not have any collateral attached to them. A bank or lender will grant this loan or credit line on the credit worthiness of the borrower along with their ability to make the agreed upon payments.  

Generally, a higher credit score will qualify you for larger credit limits and lower interest rates.  However, without the ability to claim or seize an asset if the borrower falls behind or stops making payments, the lender will most often grant these loans or credit lines at a higher cost to the borrower than when there is collateral. These loans are riskier to lenders, therefore, more costly to borrowers.    

Revolving  

Personal lines of credit, home equity lines, and credit cards are all considered revolving debt. This type of debt is considered “open-ended”, meaning that you have a set amount available (your credit limit) and can use up to that amount over and over again. You have the ability to charge, pay and then reuse as needed, as long as all payments are made as agreed, and the account stays in good standing.  

Interest rates and fees are normally higher than on a secured loan and can be fixed (doesn’t change) or variable (fluctuates) and will typically depend on your credit history. Payments are based upon the amount of debt currently owed on the account at the time it is due.  

Installment  

Installment debt is considered “closed-ended”. These loans are set up to be paid over a set amount of time with payments typically being the same amount, usually due monthly. A portion of each payment is credited toward the balance of what you borrowed, and the remaining is paid toward the interest owed. This is known as amortization.  

These loans can be both secured and unsecured. Auto loans and mortgages are an example of a secured installment loan. Student loans are unsecured installment loans.  

Mortgage  

Mortgage loans are used to purchase a home or borrow against the value of a home and are secured by that same piece of real estate. They are the most common and often the largest debt many of us carry through life. They typically offer lower interest rates than other loans and are financed over longer terms, like 15, 20 or 30 years. Extended terms are offered due to the amount of the loan in order to make payments affordable.  

Monthly payments include the principal payment (portion going to the balance of the loan) and interest as well as homeowners’ insurance, property taxes and private mortgage insurance if required.  

Credit Mix  

Having different types of debt can actually boost your credit score. Your credit “mix” makes up 10% of your FICO credit score. Further, lenders like to see that you can handle multiple types of loans responsibly and are more willing to lend to those who do.  

Understanding how the different types of debt work and what types of debt you have can help you develop a strategy for managing it and lead to more financial confidence and freedom. 

If you are looking for ways to tackle your debt, check out our podcast, Think Like a Saver, where our team discusses paying down debt.  

Take the Veteran Saves Pledge today to start your journey to a better financial future. Choose debt repayment as your goal and we’ll send you emails, text, tips, and resources to keep you motivated!