Part 2 of 3-Part Series
Unsecured debt is of course debt without any collateral for security. This kind of debt is given based upon the perceived reliability factor of the borrower and this is usually calculated in a credit profile. A financial profile is run upon you as the borrower, taking into account your income, savings, investments, existing debt, current and old bill payment history and a multitude of other factors. Based upon this, the lender determines whether you are a worth candidate for the debt as well as the interest and repayment terms if you are approved. You are likely familiar with credit scores which are commonly used these days and these credit scores are based upon the profile workup.
The next two categories, revolving debt and mortgaged debt can technically fall under secured and unsecured, respectfully. The reason is because nearly every kind of debt agreement falls under these two first categories based on their very general definition. Mortgaged debt or mortgages are what you use to purchase a house or other kind of real estate property. They would fall under secured debt as well because the actual real estate is used as the collateral in the occasion that the mortgage payments cannot be made. The reason mortgages are given their own category is because they are quite different in terms of structure, interest and payment period than all other debt. As a Canadian, this is almost always the largest debt you will ever take on in your personal life.
Revolving debt is essentially what is known as credit and this is debt which you can get from financial institutions. It is revolving because you can borrow money, repay it and then use this debt again. With revolving debt, you can do this as many times as you like for as long as you have it. Although used interchangeable, credit is the amount of money the financial institution makes available to you to borrow, and debt is the amount of money you have borrowed and still owe. For example, if you have $10,000 in credit from your bank, but have not used any of it, your debt is still $0. As you borrow from this credit, the debt increases, credit decreases and so forth. The most common type of revolving debt is of course a credit card, and next would be a line of credit.
The last unmentioned type of common debt is what corporations use and you will likely never need to use in your personal life. But perhaps you are an investor in a corporation which employs this tool, in which case it would be handy to understand. Corporations are able to issue bonds to raise money and each bond would have a set value, set interest rate and set repayment date. These bonds are sold to its investors and a debt is now owed to them. It works under the exact same basis as the previous types of debt, but the lenders are the investors in this case and the borrower (corporation) is able to raise large sums of money when needed.
Part 3 continued next week.
