Debt and the Individual

Understanding Debt

Debt refers to money owed by one party, the debtor, to a second party, the creditor.
Creditors are typically banks, credit card companies, or other financial institutions.
Debt provides a way for individuals to make large purchases, like a home or car, which they could not afford with their current income.
Debt agreements come with agreed upon payment schedules and interest rates, meaning the debtor will repay more than they borrowed.

Secured debt requires you to offer an asset (like your house) as collateral. That asset can be taken if you fail to meet your payments.
Unsecured debt like credit cards, do not require any collateral, but have higher interest rates to compensate for the higher risk to the creditor.
Student loans are a form of unsecured debt, but they typically have lower interest rates and longer repayment periods.
Mortgages are long-term loans that are used to buy property, and are considered secured debt, with the property as the collateral.

A manageable amount of debt increases your ability to make purchases or investments, but excessive debt can lead to financial stress and difficulties.
Missing payments can lead to penalties, increased interest rates, and a negative mark on your credit history.
A poor credit history can make it more difficult to secure loans or other forms of credit in the future.
Being in too much debt, or being unable to keep up with debts, can lead to bankruptcy, which has serious long term implications for financial wellbeing and credit.

Creating a budget helps track income and expenses. This can show where spending can be reduced to free up extra money for paying off debts.
Prioritising repayments by focusing on the debts with the highest interest rates first, also known as the ‘avalanche method’, can help manage and reduce overall debt faster.
Negotiating with creditors for a restructured payment plan, lower interest rates, or even debt forgiveness can also be a method of managing overwhelming debt.
In extreme cases, declaring bankruptcy can be the most effective way of managing debt, but this should be a last resort due to the long term impact it has on personal finance.