Sunday, March 16, 2008

Understanding Debt

On the surface, managing money seems like a pretty simple thing. You earn money, whether through a job, inheritance or lottery winnings; and you spend it on the things you need (or think you need). It sounds so simple, until you introduce debt into the picture. If you fail to live within your means and your expenses exceed your earnings, youll quickly find that there are ways to borrow money to make up for this disparity.

Debt is really a simple concept when you borrow money from another for whatever reason, you are in debt. And unless youre borrowing from a very generous friend, youll be required to pay back that debt at some point in time. Banks, credit card companies and other credit providers are unlikely to be as lenient. When you take on a debt, youll find that it comes with terms and conditions that govern its repayment, including the deadlines for making payments and details on your interest rate.

Understanding interest rates can get tricky with all the financial jargon of APR rates, compounding interest and so on. But on a simple level, interest is what the creditor charges to let you have access to all that money. After all, banks and credit companies arent just friendly businesses there to help you out their for-profit enterprises. In exchange for loaning you money, they expect to be paid back a certain percentage (your interest rate) on top of the original loan amount (called your principal). Thats why its so important to shop around to get the best interest rate possible a small percentage of a big debt can be a lot of money!

One of the most common instruments of debt comes in the form of a loan. A loan can either be secured to unsecured. If you have any assets, such as a house or a car, you may pledge these items as collateral to get a loan, meaning that youll turn over these assets to the credit issuer if you cant pay back your loan for any reason. This is referred to as a secured loan, since the creditor has a measure of security that theyll get their investment back. A loan is considered unsecured when the debtor does not pledge specific assets to the creditor as collateral.

Clearly, a secured loan is a safer choice for credit issuers. Often times, debtors who are able to secure their loans find better terms and interest rates, since the creditor has a means of collecting on any defaulted loan. However, having an unsecured loan doesn't mean that the debtor can renege on his or her debts. If a debtor fails to pay back the loans, the creditor can still file a case in court, requiring the debtor who has no cash to sell some of his assets to pay back the outstanding loan.

While debt can sound scary, theres nothing to worry about if you use it wisely. Building good credit from an early age by using debt responsibly can make a huge difference in the long run. But the temptation is always there to purchase more than you can afford to. Its easy to get in over your head so take the time to learn more about your finances and be smart about your money!

This article was published by Sarah Russell on Smart Young Money a collection of money management resources for teens and young adults. For great information on using credit, managing debt and more for young people, visit


Post a Comment

<< Home