A Basic Review of Debt

The concept of debt management is especially important today as Americans are saving less and are further in debt than at any other time in our history. Let us explore what debt is, when it is good and bad, how to get out from under its bondage, and what the consumer should be aware of. 

Loans Defined–An arrangement in which a lender lends money to a borrower and the borrower agrees to repay the money, usually along with interest, at some future time. If $10,000 is borrowed at 8% for four years, will have a monthly payment of $244.13. The interest cost is $1,178. Therefor total cost is $11,178, and when you receive the loan, your net worth automatically goes down by that amount.

Type                             Tax Deductible Interest?     Appreciating Asset?        Okay or Bad?

  • Home loan, or mortgage           Yes (usually)                               Yes                                  Okay with moderation

Home loans are considered okay debt because an appreciating asset has been purchased, mortgage loan interest is deductible, and some feel that is the only way home ownership can be obtained. No debt is wonderful, so even with home loans it should be used with moderation.

  • Home Equity or 2nd Mortgage   Yes (usually)                               Yes                                 Okay with moderation

Home equity loans are considered okay, because they may be deductible; except when they are used to purchase depreciating assets (furniture, swimming pool, vacation). Many people during the great recession spent their home equity foolishly, and when they ran into financial difficulty, they had little home equity because of massive loans and depreciating values.

  • Margin Loan (on investment)      Yes (sometimes)                          Maybe                          Risky, extreme caution

Margin loans are secured by an investment portfolio to purchase additional investments. Some wealthy people do this.

  • Consumer loan                         No                                              No                                       Bad

Consumer debt are loans used to purchase items that rapidly decrease in value, such as furniture, appliances, and automobiles

  • Credit Cards                             No                                              No                                       Bad

Credit cards if not paid off each month can lead to serious debt problems. Credit cards psychologically encourage over-spending for many people

  • Business loans                         Yes (sometimes)                        Yes hopefully                      Okay sometimes

Business loans are usually a term loan to invest in your business to increase its value and income.

Types of Loans: Basic

  • Term Loans are debt loan with a fixed maturity and an amortization schedule. These types of loans are usually used for autos and homes.
  • Lines of Credit  are extended by a lender to a borrower, usually without a fixed maturity. These types of loans are credit cards, home equity loans, and business loans
  • Secured Loans produce debt with some form of collateral securing the loan, such as a home.

This is the 2nd article in a 3-part series on debt. Please read all of these article to be a better user of it, and for ways to avoid and escape it.

  1. A Basic Review of Debt
  2. The Reasons and Costs of Over-borrowing
  3. The Problem with Debt and How to Get Out of It