- Debt is whenever you owe money to someone else, known as your lender.
- Good debt helps you increase your income or net worth, while bad debt is generally any other type of debt.
- There are lots of types of debt, and they can have different rules that affect how you pay it off.
- If you create a plan to get out of debt, you'll be much more successful.
Life would be great if we could always afford the things we need. But if you can't (and that's most of us), you might end up incurring some debt.
It's a good idea to have a full understanding of what it means to borrow money and pay it back—the basic definition of debt—so that no matter what happens, you can make sure you'll be debt-free one day.
Let’s review the definition of debt in greater detail by looking at the different types of credit and loans you could borrow, as well as how to repay them.
What is debt?
The official definition of debt is simple: It's when you owe money to someone else. The person or business that loaned you money is called your lender, or creditor.
Most formal types of debt have a contract that lays out your repayment, including how much your monthly payment will be and what the consequences are if you fall behind on repayment. Other types of debt, like IOUs to family or friends, might be less formal arrangements.
Many creditors, like banks, credit unions and online lenders, make a business of lending money. The interest you pay is what they use to run the business—to cover losses in case other borrowers don't pay up, to hire employees and yes, to make a profit.
Most people incur debt because they can't afford to pay for something in cash, like a house, a college education or even retail purchases. But you can take out loans for other reasons too, such as to build your credit score.
Good debt vs. bad debt
You might hear people talk about the definition of debt as "good debt" or "bad debt."
"Typically, good debt is a mortgage and student loans," says Deborah Johnson Miranda, a financial coach with Bee Money Coaching. This is because mortgages and student loans can help you increase your income and your net worth.
"Bad debt was (and still is) considered to be credit card debt, payday loans, collections and other consumer debt," Miranda adds.
Todd Christensen, education manager at Money Fit, a national nonprofit that helps people manage their debt, finds it helpful to sort debt into three categories:
Potentially beneficial debt: Debt that can help you get ahead, such as a student loan that you can use to eventually earn a higher income or a mortgage that can help you gain equity in your home.
Practical debt: This category could include things like credit cards that you pay off in full each month. They don't necessarily increase your net worth, but they don't hurt you either (as long as you pay them off promptly).
Bad debt: This is any other type of debt, such as revolving debt that you don’t pay off each month.
Christensen points out that he avoids the term “good debt” because it can give “someone a green light to take out as much as possible."
Instead, he encourages people to look at it a little differently: “Calling these 'potentially beneficial' pushes the responsibility back on the borrower to make sure they're willing to both take the risk and do the work to pay them off," he adds. That change in mindset can help you avoid overloading yourself with debt.
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Types of debt
Your debt might come with different rules that affect how you pay it off, or what happens if you don't.
Here are some common terms and types of debt you'll see out there.
Types of loans
Mortgage: A loan to buy a house, either as your primary home or an investment rental
Student loan: A loan to pay for higher education
Auto loan: A loan to purchase a new or used vehicle
Personal loan: A general-purpose loan for just about anything, such as health care, home upgrades or a car repair
Credit card: A line of credit that you can borrow against as needed for just about any purchase
Home equity loan: A loan that you take out against the equity in your home—the portion of your home that you've paid off
HELOC: Similar to a home equity loan, but in the form of a line of credit that you can borrow from as needed over a long period
Small business loan: These loans can be used for a wide range of things, like starting a business, covering shortfalls in cash flow or expanding an existing business.
Revolving vs. installment debt: Revolving credit are generally lines of credit (like credit cards) that you can borrow from at will and pay off over time. It's generally best to pay these accounts off in full each month, if you're able. Most types of loans are installment loans, where you borrow a lump sum that you repay over time with steady payments. Student loans are a common example of installment debt.
Secured vs. unsecured debt: Secured loans are backed by collateral that a lender can seize if you don't pay, like a car or a house. A mortgage is perhaps the most common form of secured debt. Unsecured loans aren't backed by collateral and can include things like personal loans and student loans. Qualifying for unsecured loans requires having good credit or a creditworthy cosigner.
Fixed rate vs. variable rate: A fixed-rate debt has an interest rate that's set when you take the loan out and doesn't change over time. A variable-rate debt fluctuates based on market forces, and that can also make your payment change over time. Sometimes a loan can have a hybrid or adjustable rate: It may have a fixed APR for a period, after which the rate may become variable.
How to get out of debt
If you're like most people, it's easy to find yourself in debt without really trying. At that point, you may be looking for how to get out of debt, and there are plenty of options. But before you can do that, you first need to create a plan.
"When I speak with a client about debt, we first look at the type of debt and whether they have enough income to pay it," says Miranda. "This means creating a budget…does the client need to eliminate some ‘wants’ to make room for debt payoff?"
Once you have a plan for where to go, you can figure out the best ways to get there. If you're having trouble, though, you don't have to go it alone.
"If you'd like some support or counseling, this would be a great time to reach out to an accredited financial counselor," says Christensen. This can be especially helpful for learning new healthy financial habits or even just having someone check how you manage things.
"If you're not in a position to send any extra payment each month, and especially if you have multiple accounts with high interest rates on them, it might make the most sense for your next call to be to a nonprofit credit counseling agency," says Christensen.
A good place to reach out to is the National Foundation for Credit Counseling (NFCC). The NFCC has nonprofit member agencies with counselors who can work one-on-one with you to find a good solution, and for a reasonable cost too.
It can be hard to get out of debt. But with a good plan, commitment and even a little help, anyone can do it.