By Managing various types of debt can feel overwhelming, but understanding how to approach each is important for maintaining financial stability. Whether it’s credit card debt, student loans, or a mortgage, different strategies can help tackle them effectively.
One common method people explore is debt consolidation, which combines multiple debts into a single payment, making it easier to manage. This article will provide practical tips on how to handle different types of debt to help individuals regain control of their financial future.
Types of Debt
Loans and credit typically fall into a few categories of debt: secured and unsecured debt, installment loans, and revolving credit. For example, loans like mortgages are secured and closed-end, while credit cards are primarily unsecured and are open-end. Each type of debt is explained further below.
Secured Debts
Secured debts are loans secured by collateral or something valuable a borrower owns, like their house, car, savings account, or life insurance policy. The lender can seize the asset if a borrower defaults on a secured loan. That’s why secured loans may be easier to qualify for. Secured loans may also offer higher borrowing amounts because the lender knows they’ll have a way to recoup their losses if the borrower fails to make their payments.
Another example of secured debt is a secured credit card. Secured credit cards require a cash deposit as collateral, which serves as the credit limit. This deposit reduces the risk for the credit card issuer and helps individuals build or rebuild their credit by using the card responsibly.
It’s important that borrowers always make their loan payments on time since secured debts require them to put an asset on the line. Failure to pay can cause them to lose their house, car, or anything else that’s been pledged as collateral for the loan. A borrower who is experiencing financial distress should reach out to their lender to discuss their options. The lender may allow them to make a partial payment or give them a chance to pay later than their due date.
Unsecured Debts
Unlike secured debts, unsecured debts consist of loans or other forms of credit that are not backed by collateral. Instead, a lender will lend a borrower money based only on factors like credit score, employment status, and debt-to-income ratio. Since unsecured debt is riskier for lenders, it can be harder to qualify for and may come with lower borrowing amounts and higher interest rates. Examples of unsecured debts include most credit cards, personal loans, and student loans.
Even though unsecured debt doesn’t involve an asset, it’s still essential that borrowers make their payments on time, every time. Otherwise, they may damage their credit score and find it challenging to get new loans and credit cards with favorable rates and terms.
Revolving Debts
Revolving debts may be secured or unsecured. Here’s how it works: Someone can borrow as much or as little as they qualify for, up to a credit limit the lender sets. Credit cards are considered unsecured revolving debt and can be used for as long as the account remains in good standing.
A home equity line of credit (HELOC) is considered a secured revolving debt because the borrower’s house is used as collateral to secure the line of credit, but there’s typically a limited draw period which is when it’s possible to borrow from the credit line. After the draw period ends, a HELOC shifts into the repayment phase.
If an individual takes on revolving debt, they should be mindful of their spending as it can be easy to overspend. It’s also wise to pay more than the minimum amount each month and make payments ahead of the due date if possible. Additionally, the careful borrower shouldn’t request a credit limit increase or accept one unless they absolutely need to.
Installment Debts
Installment loans, which can be secured or unsecured, offer a lump sum of money upfront. Then, a borrower repays it over time, often via fixed monthly payments. The most common installment loans are mortgages, car loans, student loans, and personal loans.
Like other types of debt, paying off an installment loan early can help save on interest if the lender doesn’t charge a prepayment penalty. A borrower could make bi-weekly payments, add extra to their normal monthly payment, or make one additional payment each year to help pay off their debt faster and save a lot on interest.
In addition, if the borrower receives an unexpected windfall of money in the form of a bonus, tax refund, or gift, they can put it toward paying down their installment debt. An early payoff can lead to hundreds or even thousands in savings over time.
Bottom Line
Not all debt is created equal. That’s why it’s a good idea for borrowers to become familiar with the pros and cons of each option and the strategies necessary to stay on top of it.
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About OneMain Financial
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