Debt: What is It And What To Do With It
Simply put, a debt means that you owe someone money. For example, say you borrow money from a traditional mortgage lender such as a bank or a bad credit lender like a private individual. You are under contract to repay that amount of money, known as the principal, along with interest. In this situation, the borrower would be referred to as the debtor, and the bank would be the creditor.
Why Would You Intentional Take On Debt?
People often assume debt to enhance their purchasing power in the present, before they earn the money. The creditor and debtor come to an agreement as to how the money will be repaid, and in what denominations. This is commonly referred to as a standard of deferred payment.
Types of Debt
The most common types of debt come in the form of basic and syndicated loans, bonds, and promissory notes. A borrower’s debt can be secured by some of his property through the mortgage agreement between him and the creditor. In this case, the creditor will have certain rights over said property if the debtor is unable to repay his debts and defaults on his loan agreement.
Basic Loan – This simple form of debt is an agreement between a debtor and a creditor in which the creditor lends a given amount of money, known as the principal, over a negotiated period of time. The principal, along with a certain amount of interest, is to be repaid by this set date. There is also the option of a balloon payment, where the loan can be repaid all at once.
Syndicated Loan – This type of loan is designed for certain companies and corporations wanting to borrow an amount of money that is far too risky for any single lender. Therefore, a syndicate of banks forms, each donating a portion of the sum to the debtor.
Bond – Bonds are debt securities issued for the most part by government agencies, and entitle the holder to collect on principal and interest payments. When these particular institutions want to borrow money they will sell these bonds to investors. Typically bonds have a lifetime of anywhere between three and fifty years, though long-term bonds are not as common. At the end of the specified time period, the money will be paid back. During the bond’s tenure, the borrower must also pay interest, known as bond coupons, consistently.
In general, debt is described in terms of a certain form of currency. Therefore, sudden changes in the currency’s valuation can have an effect on the size of a borrower’s debt. These fluctuations, known as inflation and deflation, can be very frustrating. It is important for the creditor and debtor to agree on the standards of deferred payment before occurrences such as these take place.
The U.S. government attempts to control the effects of inflation by issuing inflation-indexed bonds, both Treasury Inflation-Protected Securities (TIPS) and I-bonds. The risk from inflation is erased, making these types of bonds the safest form of investment.
Effects of Debt
Debt allows individuals and companies to spend money that they don’t have. In a lot of cases, people use debt to buy houses and cars. In terms of the big picture, some believe debt is good for society. It shows that society is looking forward, and confident in its ability to generate money in the future. Opponents believe that debt promotes a weak work ethic, and that it postpones present problems to a later date.