Personal debt is not necessarily a bad thing, otherwise how would anyone be able to be able to buy a house. However, it does need to be controlled and managed properly because it can easily get out of control.
Owing and personal debt is the third part of our series about Mastering Your Finances. We’ve covered Earnings and Spending, here we take a look at the different types of money that you might owe.
Personal debt comes in various forms, each with its own characteristics, terms and implications for you, the borrower.
Understanding the different types of personal debt can help you manage your finances more effectively.
Here are the main types of personal debt:
- Credit Card Debt
- Personal Loans
- Student Loans
- Mortgage Loans
- Payday Loans
- Retail Financing and Shop Credit Cards
Credit Card Debit
Characteristics: Unsecured debt with credit limits as to the maximum spend.
Terms: High-interest rates; minimum monthly payments required.
Implications: Can quickly accumulate due to high interest; affects credit score if payments are missed.
Personal Loans
Characteristics: Unsecured or secured loans provided by banks or online lenders.
Terms: Fixed interest rates and monthly payments over a specified term (usually 2-7 years).
Implications: Used for various purposes like debt consolidation, large purchases or vehicle purchase.
Student Loans
Characteristics: Loans designed to pay for university costs in respect of fees or living costs.
Terms: No fixed terms as repayment does not start until earnings are above £24,900. The interest rates depend upon the year taken as they are linked to RPI or Bank Base Rate +1%. Repayments made directly from earnings by your employer.
Implications: Long repayment periods means that interest accumulates on interest if the repayments do not cover the amount of interest charged. You will definitely end up paying back far more than you borrowed.
Mortgage Loans
Characteristics: Secured loans taken out to facilitate property purchase.
Terms: Long-term loans (15-30 years); fixed or variable interest rates.
Implications: Home serves as collateral; missing payments can lead to foreclosure.
Payday Loans
Characteristics: Short-term, high-interest loans intended to cover immediate expenses until the next payday.
Terms: Must be repaid quickly, often within weeks; extremely high interest rates.
Implications: Can lead to a cycle of debt due to high costs and short repayment terms.
Retail Financing and Shop Credit Cards
Characteristics: Credit extended by retailers for purchases within their stores.
Terms: Often come with promotional offers (e.g. 0% interest for a certain period); high interest rates after the promotional period.
Implications: Can lead to high-interest debt if not paid off during the promotional period.
Managing different types of debt
Understanding the specific characteristics of each type of debt can help you prioritise repayment, negotiate better terms and avoid common pitfalls associated with high-interest or revolving debts.
It’s important to always read the small print and consider the long-term implications before taking on any new debt.
In our next article we will cover how you can manage and control debt so that you control it and not it controlling you.
If this article has raised questions that you’d like us to answer, please get in touch.