Part 1 of 3-Part Series
Understand debt and what it entails is one of the most important lessons everyone should learn. However, it is likely one of the least understood financial tools and most often thought of in negative terms. At its very core, debt is borrowing money. What it is used for and how you manage it is what makes it good or bad and determines whether it is good or bad debt. When used with care and thought, it is an invaluable tool which can be used to make purchases you could not normally afford or manage your expenses. But when used improperly and unwisely, it has the potential to destroy your entire future.
Let’s first discuss what debt really is as there is much misunderstand among the general public. Debt is money which is borrowed from one party, known as a borrower, from another party which is known as a lender. In this debt agreement or arrangement, the borrower receives a set sum of money with the condition it must be paid back at a later date, and usually with interest. All of these stipulations are set out in the original agreement and signed by both parties. Typically, the borrower will take on debt in order to make a purchase of something which they cannot afford to pay off in full at that time, or to help with ongoing expenses.
Debt is classified among 4 main categories which are secured debt, unsecured debt, revolving debt and mortgage debt. Secured debt means that there is collateral which used as security for the debt. Collateral is usually an asset of value equal to or greater than the value of the money borrowed and if the borrower defaults or is unable to repay the loan then the lender can take ownership of the asset. They can subsequently sell the collateral in order to recoup the value of the debt given. Collateral is often things of large value such as houses, cars or boats, but can also include investments and securities or anything deemed to be of value. In large debt agreements, the value of the collateral is sometimes assessed and verified by independent parties so there is even more security for the lender.
Part 2 continued next week.