According to Experience 2019 Consumer Debt Study, Americans carry an average of $90,460 on personal debt, whether you have more or less than ninety $90,000 of debt, chances are you have some debt. Before jumping into conclusions about what this means for your financial health, let's learn more about how that works. In this lesson, you'll learn about the basics of debt, including the roles of the lender and borrower and how to calculate the cost of borrowing money. You will also be able to identify different types of debt and how your debt impacts your credit score. Simply defined, debt is an obligation of a borrower to repay money to a lender, this can be as informal as asking a friend or borrow $1 to buy a soda, but for the purpose of this lesson, we'll refer to the more formal relationship that often exists between you and a bank. A lender can be a bank or any other financial institution in the business of supplying loans or other types of credit. You, the customer, are known as the borrower, the individual borrowing the money with a promise of paying it back. The details of how you'll pay the money back, including when, how often and in what amounts, are what are known as the terms of borrowing. A line of credit, like a credit card that is available to you on an ongoing basis, which can be drawn upon, paid back and drawn upon again is known as revolving debt. A loan provided to you in a lump sum like a student loan, car loan or mortgage, which you eventually pay back in equal amounts monthly for a predetermined number of years, is known as installment debt. The amount you borrow is called the principal. This amount will be paid back in full with interest. Lenders make money by charging interest on credit offered and the amount they will charge will be determined by a variety of factors. First, the type of debt will dictate an appropriate range of interest rates to charge. Secured debt, which are debt obligations backed by an asset you pledge as collateral generally come with lower interest rates as they are relatively low risk to the lenders. These debts are lower risk because the lender has the ability to take ownership of the collateral if you default on the loan. Examples of secured debt include mortgages when a property services the collateral or an auto loan, when a vehicle is a collateral. In either case, if you were to fail to pay back your loan, the bank would have the ability to assume ownership of the property. The risk of loss to the lender is relatively low and therefore they can afford to charge you lower interest rates. Unsecured debt, which does not have any type of collateral, works a little bit differently. Unsecured debts include credit cards and personal loans. Since these types of credit do not have collateral, the lender takes on more risk when lending to you, so they will account for that risk by charging higher interest rate. Whether debt is secured or unsecured is just the first in a variety of factors which can determine an appropriate interest rate. The most important takeaway, though, is that unsecured debt, where there is no collateral, is higher risk to the lender. You as the borrower can expect unsecured debts to come at a higher cost than your secured debts. The next variable that a lender will use to determine the terms in which they will lend to you, will be your credit worthiness. In many cases a decision will be made primarily based on your credit score. By having a strong credit history and a good credit score, you will be more likely to secure an account with the lender and will likely also receive more favorable terms, such as a lower interest rate than someone with fair or poor credit. Having a good credit score will ensure that you will be able to access credit when you need it. Maintaining good credit throughout your lifetime will help keep your cost of borrowing lower since you will have lower rates on your debt, potentially saving you tens of thousands of dollars over time. There is a lot to know and think about when it comes to having debt, but with a fundamental understanding of how lenders determine who to offer credit to and on what terms you are now better equipped to navigate borrowing moving forward.
