What is Debt and How Should I Handle It?

Debt is money borrowed that has to be paid back over a period of time. Lending institutions, like banks, will lend you money so you can make a purchase. In turn they expect you to pay them back, with interest. Debt can be classified in two broad categories: corporate debt vs. personal debt. Corporate debt involves loans between businesses and, generally speaking, has little to no impact on personal debt. This article will explain the most common types of consumer (personal) debt and how to handle it. 

Secured debt

Secured debt is debt with the promise of collateral if the loan agreement is broken. Examples are mortgage loans and car loans. If you don’t make your mortgage payments, the house goes through foreclosure, and the bank gets your house. If you don’t make payments on a home equity loan, the equity in your home is collateral. If you don’t make payments on your car loan, the loan company can repossess your car. A secured store credit card could have an agreement that the store can take back the property you charged or an agreement that you put a cash deposit on the card first. 

Collateral is the loan company’s security interest. Loan agreements that are made with collateral usually have lower interest rates. The Consumer Financial Protection Bureau reported 30-year mortgages to homeowners with good credit have had rates averaging between 3.95% and 4.94% over the past couple years. The Federal Reserve System reports new car loans have been running between 5.05% and 6.11% during the last couple of years. These rates are far lower than the interest charges on unsecured debt.

Unsecured debt

Unsecured debt is debt that is made without collateral. When you get a credit card and don’t put down a deposit on the credit card, that credit card is unsecured debt. The credit card money is a loan. You did not promise the credit card company that they could take your house or car if you defaulted on the loan. There is no collateral promised for unsecured debt. 

When you take out an unsecured loan, the loan company must go through a legal process to get a judgment against you to get their money back. Why would a creditor give you a loan without collateral? Because they can make money on interest, or because it is in their best interest for economic, legal, or social reasons. Interest rates are higher on voluntary unsecured debt. Popular credit cards are trending with a rate of just over 17%, but the average credit card interest rate is near 20%. The Federal Reserve reports rates between 15%-18% from commercial banks. 

First, know that there is a difference between voluntary and involuntary debt. If you were rushed to the hospital or couldn’t pay your heating or cooling bills because of uncontrollable weather, you incurred involuntary debt. If you signed a credit card agreement or a student loan, you incurred voluntary debt. Life is unpredictable, and voluntary debt and involuntary debt can pile up fast when it’s hard to make ends meet. Next, let’s dig deeper into some details about credit card debt, personal loans, and student loan debt. 

Credit card debt & personal loans

When you take out credit card debt you immediately have the power to buy things in an emergency, make repairs, buy gifts, and have a nice meal or a night out to celebrate. You have spending power. If you’ve got a credit card that offers points, you’ll be able to accumulate points for gas, air miles, or even cash back. The U.S. economy thrives on spending, and credit card debt is big business. Government data shows consumers are over $100 billion in debt, and in 2018 creditors assessed over $10 billion in late fees.

There’s always an emergency, always something to repair, always something to improve, and always somewhere to go. Once a late payment tacks on late fees, credit cards can charge outrageous rates, and defaults on payments can bury the possibility of keeping up with personal finances. The less you pay, the more into debt you go. When you make just the minimum payments, the interest you pay keeps adding up, and the credit card company, credit union, or bank starts to rake in money on your misfortunes

A personal loan can help you with an addition on the house for the unexpected child, books for school, medical exams, weddings, or surgery for your dog. A personal loan improves your life, but the scales of the economy weigh you down with monthly payments and interest payments that accumulate if you get off track with your payments, and it’s easy to lose track of missed payments. The bills aren’t touching your life like rent and utility payments or your bank statement, but they still wreak havoc in the background. Interest rates on personal loans often range between 9.75% and 10.65%. Your debt may accumulate until you realize it’s just not possible to make payments anymore. That’s when the debt collectors start calling.

A debt collector can work for an agency, work independently, or even be an attorney. Debt collectors usually get a percentage of the amount collected, so the more they get from you, the more they make. Another type of debt collector is a debt buyer. A debt buyer will buy the debt for less than the total amount and then keep the amount collected. Now you know why collection agencies are persistent with phone calls and letters. 

Some people pay for tuition or school books using personal loans, but school loans for students are usually government-backed and have long repayment plans, so they are usually excluded from debt relief programs not specifically created to deal with student loans. 

Student loan debt

Student loan debt is debt incurred to attend a college or university. If you went to college, you probably filled out a FAFSA and got a loan to help pay your tuition. School loans for students can come from the government (federal loans and state loans), or a non-government business, like a bank or credit union. You may have heard of PLUS loans or Perkins loans—these are federal student loans. You may have also heard of Sallie Mae loans. Back in 1972, Sallie Mae was a lender of federal loans, but in 2004 Sallie Mae went private. Today, Sallie Mae offers private loans for students to use for school, and they offer information on federal loans, but not federal loans for students. Student loans are generally not dischargeable in bankruptcy. 

Across the United States, there are over a trillion dollars of outstanding student debt. The average student has over $35,000 in student debt when they leave college. Lawyers usually walk out with over $100,000 worth of law school debt, and they’re part of the two million students that owe over $100,000 in student debt. Over 44 million Americans are burdened with thousands of dollars in student debt that was acquired while trying to get an education to improve themselves. Think you have too much debt?

I have too much debt - what should I do? 

Your debt may feel overwhelming, but it’s just a drop of water in the debt that drives the nation’s economic engine. Americans owe $4.12 trillion in non-housing debt and $9.33 trillion in housing debt. If you owed $41 million in bad debt, you wouldn’t even owe a fraction of a percent of the country’s non-housing debt. Debt is an American way of life. You are not alone, and your debt won’t last forever. There are programs you can use to reduce most, and maybe even all, of your debt. 

Debt relief through bankruptcy

Bankruptcy is a legal process that resolves your debt through liquidation of your assets, repayment plans, or reorganization. Creditors get paid what you can pay. If you can’t pay, the qualifying debt gets discharged. 

Many people are attracted to bankruptcy as a debt relief option because when you file bankruptcy, you get an automatic stay that stops most of your creditors from taking any collection action against you. The automatic stay is a stop order that gives you time to breathe and reorganize your personal finances. An automatic stay is ordered in a Chapter 7 and Chapter 13 bankruptcy. 

A Chapter 7 bankruptcy will liquidate your unprotected assets (if you have any) to pay down debt, and a Chapter 13 will allow you to make debt repayments according to an approved payment agreement. To file a Chapter 7 bankruptcy, you’ll have to be within a certain income limit and pass a Means Test to evaluate your financial situation. If you make too much money, you’ll likely need to file a Chapter 13 bankruptcy. The not-so-bright side of bankruptcy is that it stays on your credit report for 7-10 years. 

Debt relief through debt consolidation

If you have debt but your credit history reports a decent credit score, it’s possible to resolve your past-due debt through debt consolidation. If you don’t want to consider bankruptcy and your creditors aren’t helping you resolve your debt, a consolidation loan could be a solution for you. Debt consolidation involves taking out a new loan to pay off the total amount of your old debt. The goal is to get a new loan that ends up saving you money and time while paying off debt. Ideally, a credit card company would offer you a 0% interest credit card with minimal fees so you can process a balance transfer. Your new payments should be affordable so you can pay off the new debt without creating more debt, and save some money. 

Debt management plans as an alternative to debt consolidation

If you can’t qualify for a reasonable debt consolidation loan, a debt management plan that offers monthly payment plans may be a more realistic debt relief solution. A debt management plan (DMP) is another form of debt consolidation, but instead of lumping your total debt into a single loan, you consolidate your monthly payments. You first talk to a free, certified credit counselor to see if a DMP is the best plan for you. 

Through a debt management program, someone else can collect your one monthly payment and they will send your payments to creditors. Before you pay, negotiations with creditors will be made to lower interest rates and forgive late fees. Many people like a debt management plan because they only have to pay one person instead of juggling a handful of creditors. Of course, you can always try to negotiate with creditors on your own, but DMP agents tend to have connections and experience that results in lower rates. 

A debt management plan exists to help with unsecured debt like credit cards and medical bills—not secured debt like mortgages and auto loans. It can’t help with child support, alimony or school loans either. But, if stacks of credit card bills are nagging you, a debt management plan may be the key to quieting them down. It’s a lot easier to pay one bill a month than twenty!

Debt settlement

A debt settlement is an optional debt-relief method that pays off a big chunk of your debt and allows you to have a certain percentage forgiven. Negotiations are made with the creditor to settle the entire debt for less than the total amount owed. The IRS isn’t as forgiving as the creditors. You may owe the IRS taxes on the amount of debt forgiven if the amount is over $600. Also, collection activity can continue until and unless you and the creditor reach an agreement, and your credit report will show that you did not pay the total debt owed. 

Debt settlement is not the option to use if you are concerned about your FICO credit score, but it will get your debt paid off and it could save you a good amount of money to help you reach your financial goals. A debt settlement option is best if you only have a few creditors and you have assets or income to pay off some debt. You’ll have to prove your financial circumstances, and creditors will want to see you can pay off the debt before any agreements are made. A debt settlement company may be able to help you with negotiations.

Conclusion

Secured debt and unsecured consumer debt are meant to be paid back. Loans are serious financial obligations, but life sometimes throws a curve ball. Even if you missed several payments, there are different types of debt relief options you can use to resolve your debt. Perhaps you can manage monthly payments, debt consolidation, or debt settlement. Maybe you’re ready for the fresh start that a Chapter 7 or Chapter 13 bankruptcy can give you, so you can get rid of bad debt once and for all and experience life being debt-free. 

Upsolve can help if you want to file bankruptcy on your own, find a bankruptcy attorney, or find a credit counseling agency to help you look into debt relief options. Take time to do some research and discover the best debt relief option for you.