Types of Debt

Understanding how debts are classified and how the classifications work can help with financial decision-making.

In the simplest terms, a person incurs debt when they borrow money and agree to repay it. Common examples include student loans, mortgages, and credit card purchases.

But did you know that those loans are actually considered different types of debt? Debt is often divided into four categories: secured, unsecured, revolving, and installment. And, as you'll see, the categories often overlap. Read on to learn more about how debt is classified.

1-Secured Debt

Collateral can take the form of cash or property, and it can be taken if borrowers fail to make payments on time. Keep in mind that failing to pay a secured debt can have other consequences. For example, late payments could be reported to credit agencies, and unpaid debt could eventually be sent to collections.

A secured credit card, for example, requires a cash deposit before it can be used for purchases. Think of it like a security deposit you put down to rent an apartment. Mortgages and car loans also represent secured debt, with the purchased property, such as the house or car, typically acting as collateral.

However, collateral has an upside: reduced risk for the lender could mean more favorable financing terms and rates for the borrower. And some lenders may also be less strict regarding credit score qualifications.

2-Unsecured Debt

Lenders examine your credit by using credit reports. That holds true for most debts. However, lending criteria can differ. Creditors generally take into account things like your payment history and outstanding debt. Such factors are also used to calculate credit scores, another tool lenders might use.

In general, the higher your credit score, the better your options. In an unsecured credit card, for example, a higher score could help you qualify for higher credit limits or lower interest rates. Some cards may offer perks like cashback, reward miles, or points. Keep in mind that a higher score does not guarantee approval for unsecured cards or other loans.

And just because a debt is "unsecured" does not mean that late payments are okay. Falling behind can still impact your credit and eventually lead to collections or a lawsuit.

If you qualify for a revolving credit line, your lender will establish a credit limit, which is the maximum amount you can charge to the account. Your available credit then fluctuates each month, depending on how much you use. Minimum payment amounts can also change every month. And any unpaid balance carries over to the next billing cycle with added interest. The best way to avoid interest charges? Pay in full every time you receive a bill.

Installment Debt

Installment loans can be secured. That's the case with car loans and mortgages. Installment loans can also be unsecured. That's the case with student loans. A buy-now-pay-later loan, known as BNPL for short, is another type of installment loan.

When making installment debt payments, you are paying back what you borrowed and the interest simultaneously. Often, the portion of each payment allocated to interest decreases as the loan is paid off. This process is known as amortization.