What are the different types of debt?

Debt is a legal obligation to repay borrowed money, and the decision to enter into it should not be taken lightly. You are committing a portion of your financial resources to someone else, which can impact your daily living and future goals of saving and retirement.

When used wisely, debt may be a helpful tool for reaching some of your goals. But mismanaged debt can lead to instability, damaged credit and legal consequences.

When considering going into debt, it’s essential first to understand some basic concepts:

• The principal is the amount borrowed.
• Interest is the cost you pay the lender for borrowing money, usually calculated as a percentage of the principal.

Different Types of Debt

• Installment loans: These loans are repaid in fixed, regular payments over a set period.
• Secured loans: These are backed by collateral or the pledge of an asset to cover the loan in case of default.
• Unsecured loans: These loans require no collateral but typically carries higher interest rates since the lender assumes more risk.
• Revolving credit: allows repeated borrowing up to a set limit

The Seven Most Common Examples of Debt

Below are the seven most common examples of debt, each serving different financial purposes:

1. Mortgage Debt

   Mortgages are long-term loans (typically spanning 15 to 30 years) used to finance the purchase of a home or real estate. These are considered secured loans, as the purchased property serves as collateral. Mortgages require a significant down payment and a good credit history. Should the property value decline over the life of the mortgage, you could owe more than the property is worth. If payments are missed, the lender can take possession of the property (foreclose).

2. Auto Loans

   Auto loans help finance vehicle purchases and are secured by the car as collateral. Terms typically range from 36 to 72 months. The size of the down payment and interest rate may depend on your credit history. Since the vehicle’s value will rapidly depreciate, often faster than the loan is paid off, you could owe more than the car is worth. As with a mortgage, the lender can repossess the car if enough payments are missed.

3. Student loans

   Student loans help cover education-related expenses, including tuition, books and living costs. These are unsecured loans and may range from 10 to 30 years. Unlike most other types of debt, these loans generally cannot be discharged through bankruptcy, resulting in a lifelong obligation. If you’re considering a student loan, remember that not all degrees may result in higher-paying positions, making it challenging to justify the cost of education in relation to the income generated.

4. Credit card debt

   Credit cards offer unsecured, revolving credit and are widely available from banks, financial institutions and retailers. Credit cards typically come with relatively high interest rates. Since only a minimum payment is typically required, this can result in prolonged repayment periods and higher interest payments if the balance is carried over from one month to the next.

5. Personal loans

   These loans are used for various expenses, such as home improvement, medical expenses and other personal needs. They’re offered by banks, financial institutions and a variety of other lenders and may be unsecured or secured, depending on the lender’s requirements. Specific terms also vary by lender, but they typically have shorter repayment periods, which can lead to higher monthly payments.

6. Lines of credit

   Lines of credit allow borrowing up to a set limit. The most common is a home equity line of credit (HELOC). A HELOC allows you to borrow up to a certain percentage of your home’s equity (the difference between the current market value of your home and the amount you still owe on your mortgage), with your home used as collateral. These loans are often used to cover large expenses, such as home renovations. A HELOC reduces the equity in your home, and depending on the housing market, you could end up owing more than your home is worth.

7. Payday loans

   A payday loan is a short-term, high-interest loan designed to cover expenses until your next paycheck arrives. They are offered at extremely high interest rates and fees. The short repayment periods and high interest rates can lead to a perpetual cycle of borrowing. Additionally, payday lenders are often known for their aggressive collection practices. Financial experts (and GuideStone) do not recommend using payday loans and strongly encourage considering alternatives!

What to Ask Before Taking on Debt

Use this checklist to help ensure you’re prepared to manage debt responsibly:

• What is the total cost (principal, interest and other fees) over the life of the loan?
• Can I afford the monthly payments?
• What are the risks if I can’t repay it?
• Is this debt helping me achieve a long-term goal?

Remember, missing payments or defaulting can result in loss of collateral, a damaged credit score, wage garnishments or other legal action. Understanding the types of debt and their implications is the first step toward smart borrowing and financial stability.

Looking for more help? Check out our helpful resources and calculators. For additional guidance, browse and watch our webinars for tips on money management and good financial stewardship.

At GuideStone^®, we want every servant of Christ to finish well. Our mission is to enhance financial security and resilience for those who serve the Lord.

For more information, contact us at Info@GuideStone.org or 1-888-98-GUIDE (1-888-984-8433) Monday through Friday, 7 a.m. to 6 p.m. CT, to speak with a customer solutions specialist.

The information in this article is for educational purposes only and is provided with the understanding that GuideStone is not rendering legal, financial or tax advice. We encourage you to consult with appropriate counsel and other advisors on all of your unique financial obligations and requirements.