DEBT
Debt can be simply understood as the amount owed by the borrower to the lender. A debt is the sum of money that is borrowed for a certain period of time and is to be return along with the interest. The amount as well as the approval of the debt depends upon the creditworthiness of the borrower. There are different types of debts that vary with the requirements of the borrower.
What is debt?
The answer to the question, "what is debt?" is the sum that a person borrows from the other is called a debt. Debt is an amount of money one borrows and has to pay back later. Everyone, be it an individual or a corporate firm, has debt at least once in a lifetime.
Before taking debt, one must be very careful because the amount of repayments is always higher than the sum borrowed. Moreover, debt always comes with a fee. The credit providers always charge a certain amount on the credit or the debt, which is known as interest.
Debt definition
When a party or corporation borrows money to make big purchases or investments that are normally unaffordable and has to be repaid within a certain time, along with an interest, such borrowed sum is called debt. Some of the famous forms of debt are:
- Loans
- Mortgages
- Credit Card Debt
- Personal Loans
Debts and their types
After understanding "What is Debt?” let's move to its type. Debt can be classified under four major categories:
Secured debt: A collateralized debt is known as a secured debt. Here the borrowed amount is secured and backed by the collaterals such as assets and properties of a value good enough to cover the debt.
The collateral that can be used here are investments, securities, boats, vehicles, property, and other pricy assets. An agreement is drafted by pledging the collaterals as the security.
If the borrower fails to pay back the debt, these securities are liquidated to repay the debt. Therefore, the debts that are secured by pledging the borrower's collateral are known as secured debts.
Unsecured debt: Unlike secured debts, unsecured debts need not be covered by any collateral as a security. Such debts are facilitated only on the basis of the borrower's creditworthiness; hence do not involve any collateral assignment.
The approval of the debt purely depends on the credit profile of the debtor.
The instances of unsecured debts are student loans, credit cards, and loans for automobiles.
The amount of loan approved depends on the financial position of the borrower or the debtor including the liquid cash, and employment status.
Revolving debt: Revolving debt meaning is more like a recurring debt. Here the debtor borrows the debt, uses it, repays it, and then again borrows it.
- There is a certain limit up to which a borrower can take the debt.
- The borrower can again borrow up to the same amount once he repays the previous debt.
- It is more like a line of credit that can be borrowed continuously.
- An example of such debt is a credit card, where the user can reuse the credit limit until he continues to fulfill the obligation of timely payments.
- A good repayment record may also increase the amount of revolving debt in the future.
Mortgage: Mortgage is another form of debt that is often used to buy real estate, such as homes. This is more like a secured debt covered by the subject of real estate.
- The mortgage approval depends on the baseline credit scores.
- The required credit score varies with the type or amount of mortgage.
- These are said to be the longest kind of debt and can go up to fifteen to thirty years.
What is a corporate debt?
Corporate debt: Corporate debt meaning can be understood as follows:
When companies borrow funds, such debts are known as corporate debts.
- Corporate debts are the debts borrowed by companies for business purposes.
- The most common instrument of corporate debt is a Bond.
- A company can raise funds by selling bonds.
- Bonds work by promising the bondholders a certain rate of interest throughout the investment period, along with the repayment of the face value on the decided maturity date of the bond.
- In the case of bonds, the lenders are the investors, and the borrower is the company that raises funds through bonds.
Pros and cons of debts
Advantages:
- Helps in financing the business not having enough capital
- Helps in business expansion
- Helpful in making big purchases
- Decreases the tax obligation
- Opens the way to new opportunities, ex- student loans, expanding business overseas, etc.
- Debt is a convenient and legal method of financing
Disadvantages:
- Debt enhances the insolvency risk.
- Debt always comes with interest which can be a big amount for many.
- Can risk personal assets and collateral in the case of secured debts.
- Can restrict new debts until the repayment of the previous ones.
How collateralization can be defined?
When the borrower's valuable assets are put to use as a security against the loan or debt issued it is called collateralization. The collaterals are seized to offset any loss arising out of non-payment of the debt by the borrower.
How many types of debts are there?
The debts can be classified into four major categories.
What is the difference between a loan and a debt?
The loan and debt often go synonymously. A debt is owed by the borrower to the lender, whereas a loan is a form of debt.
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