What are the different kinds of debt detailed overview
May 26, 2023What are the different kinds of debt?.jpg)
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You might think that debt is just debt, but different types of loans and other debts have their own payment plans, tax implications, and impacts on your credit scores. Ideally, you would want to have various types of debt on your credit reports because it shows lenders that you can balance your finances. A diverse credit history can also help your credit scores.
One of the factors used to calculate your scores is your credit utilization ratio. This refers to the amount of money you owe in relation to the total amount of credit available to you. For example, if you have a credit card with a $5,000 limit and currently owe $1,000, your credit utilization rate on that card would be 20 percent. Most creditors want to see a credit utilization rate of 30 percent or less across all your revolving accounts.
So, what makes credit card debt different from medical bills, a mortgage, or a student loan? Here's a breakdown of some of the most common types of debt and how they can affect your finances:
Credit card debt
- Loan type: Credit card debt is considered a revolving account, which means you don't have to pay it off at the end of the loan term (usually at the end of the month). It is also an unsecured loan, which means there is no physical asset like a house or car tied to the loan that the lender can repossess to cover the debt if you don't pay.
- Interest rates: Rates vary depending on the card, your credit score, and your history with the lender, but they tend to range between 10 and 25 percent, with an average interest rate of around 15 percent.
- How to pay it off: To stay on track, you need to make a minimum payment on your credit account each month if you have a balance. However, paying only the minimum can allow interest charges to accumulate and make the debt nearly impossible to pay off. Resolve existing credit card debts by paying as much as you can above the minimum, then commit to not spending more each month than you can afford when your statement arrives.
- Tax implications: None, as payments made towards credit card debts are not tax-deductible.
Ramifications for your credit scores: A long history of on-time payments can be good for your credit scores. Just be careful not to open too many accounts or get too close to your credit limits.
Mortgages
- Loan type: Mortgages are term loans, which means you pay them off in a set number of payments (installments) over an agreed-upon term (usually 15 or 30 years). They are also secured loans, which means the home you purchased with the mortgage serves as collateral for the debt. If you fail to make payments, the lender can initiate the foreclosure process, which typically involves seizing the property and selling it to recoup their money.
- Interest rates: Depending on the state of the economy, home mortgage interest rates tend to range between 3 and 5 percent. If you have an adjustable-rate mortgage (ARM), your interest rate may change from year to year within certain parameters.
- How to pay it off: Typically, you make one mortgage payment per month for the term of the loan. Although some mortgages may require bi-weekly payments, they are fairly rare.
- Tax implications: The interest you pay on your primary residence mortgage is tax-deductible up to $1,000,000 ($500,000 if married and filing separately). The interest paid on a home equity loan is also tax-deductible up to $100,000 ($50,000 if married and filing separately).
Ramifications for your credit scores: As long as you make your payments on time, a mortgage can often help your scores because it shows you're a responsible borrower. Having a mortgage helps diversify your credit portfolio, which can also benefit your scores. It's worth noting that this type of debt doesn't count towards the credit utilization portion of your credit scores.
Auto loans
- Loan type: Like a mortgage, an auto loan is a secured term loan. It is paid off in a set number of payments over an agreed-upon period (often three to six years). If you fail to make payments, the lender can repossess your car and sell it to recover their money.
- Interest rates: The longer the term of your loan, the lower your interest rate is likely to be. Many car manufacturers offer zero-interest or low-interest financing deals for people with good credit.
- How to pay it off: Since it is a term loan, you pay it off in a set number of monthly payments over several years.
- Tax implications: None, as payments made on auto loans are not tax-deductible.
Ramifications for your credit scores: Similar to a mortgage, making timely payments on your auto loan will help build a positive credit history and improve your credit scores.
Student loans
- Loan type: Student loans are unsecured term debts, but the repayment terms are more flexible than other loans.
- Interest rates: Interest rates on student loans vary. If you apply for a student loan through the U.S. Department of Education, the interest rate is set by the federal government and will remain stable for the duration of the loan.
- How to pay it off: Generally, student loan payments are calculated for a 10-year repayment period. However, this is not set in stone. For example, if your payments are more than you can reasonably afford, your loan servicer may place you on an income-driven repayment plan with a lower monthly payment.
- Tax implications: The interest paid on student loans is tax-deductible up to $2,500 as long as your gross income doesn't exceed $80,000 (or $160,000 if married and filing jointly).
Ramifications for your credit scores: Student loans are often some of the first debts borrowers take on, so they can be an important means to build a strong credit history. As with other debts, paying your student loans on time each month helps improve your credit score.
Medical debt
- Loan type: Medical debts are unsecured by any kind of property and usually don't come with an assigned payment period or structure. Most hospitals and other healthcare providers have a billing department, and you can often work with your provider to set up a payment plan if you can't pay the full amount of your bill immediately.
- How to pay it off: This really depends on your doctor or hospital. Ideally, they want you to pay everything at once, but that might not be possible if you've had, for example, an extended and costly hospital stay. Again, speak with the billing department of the provider to see if you can work out a payment plan or negotiate a lower price for the services you've received.
- Tax implications: Qualified medical expenses that exceed 10 percent of your adjusted gross income may be deducted from your federal taxes.
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