2606: The Types of Debt Explained by Jackie Beck on Paying Down Debt & Building Wealth

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[00:00:29] starts with a good night's sleep. Just search for good sleep in your podcast app and be sure to pick the one from Optimal Living Daily. This is Optimal Health Daily, episode 2606. The Types of Debt Explained by Jackie Beck of JackieBeck.com and I'm Dr. Neal Malik.

[00:00:49] Hey there and welcome to another Sunday bonus episode where I share an article from one of the other podcasts in our network. Today's post comes from Optimal Finance Daily, where articles covering everything from saving to budgeting to investing and more are read to you every day.

[00:01:06] You can find Optimal Finance Daily wherever you're hearing this. So with that, here's Diana with the post and commentary as we optimize your life. The Types of Debt Explained by Jackie Beck of

[00:01:23] JackieBeck.com. When it comes to personal finance, debt is any money that you owe and at the most basic level that can be broken down into two main types of debt, unsecured debt and secured debt.

[00:01:38] But you may also hear it as three types of debt. That's because sometimes people break secured debt down into an extra category by separating out mortgages, which are a type of secured debt. So if you look at it that way, the three types of debt are unsecured loans,

[00:01:54] secured loans and mortgages. Good debt versus bad debt is a whole different thing. We'll go over the various types of debt in more detail next, starting with secured debt. What is secured debt? Secured debt is when you have something that you put up as collateral in

[00:02:12] case you don't repay it. If you don't repay what you owe as promised, the lender can take whatever you pledged as security. Then they can sell that item to recover at least part of what you owed.

[00:02:24] That's why it's called secured debt. For example, if you don't repay your car loan, the lender can repossess your car. If you don't make your mortgage payments, the lender can foreclose on your house. Either way, you end up without the item that was securing the loan. Usually,

[00:02:41] secured debt is backed by a physical item, but not always. For example, with secured credit cards or some utilities, the collateral is money that you've deposited ahead of time. Here are some examples of secured debt. Mortgages, car loans, HELOCs or home equity lines of credit, car title

[00:03:02] loans, secured credit cards, personal loans if you pledge something as collateral and utility bills covered by a deposit. Secured debts are often installment loans, but not always. More on that later. Now let's move on to the other major type of debt, unsecured debt. What is unsecured debt?

[00:03:25] Unsecured debt is just like it sounds. It's debt that is not backed by property or money that the lender could take if you don't repay them, unless the court orders otherwise. And of course, the

[00:03:35] lenders would still have the right to collect from you. Instead, unsecured loans are made to you based only on your credit worthiness, also known as how likely the lender thinks you are to repay them.

[00:03:48] Here are a few examples of unsecured debt. Most credit card debt, charge cards, personal loans if you don't pledge anything as collateral, student loans, medical debt, payday loans, utility bills if you didn't have to leave a deposit, overdrafts and paid memberships. If you're curious, based on

[00:04:10] the New York Fed's number of accounts by loan type chart, credit cards are the most common form of debt for U.S. households. Note that in general, interest rates are higher for unsecured loans

[00:04:21] versus secured loans. These unsecured types of debt can be one of any of the four types of credit. So on a related note, let's talk about the types of credit. What are the types of credit? Debt and

[00:04:35] credit are like two sides of the same coin, except debt is money you owe and credit is usually money someone is willing to lend you. The types of credit are broken down into installment credit, revolving credit, charge cards and service credit, sometimes also called open credit.

[00:04:55] Let's talk about each one of those next, starting with installment credit. Installment credit is where you borrow a set amount and make fixed payments over a set period of time. If you make all your payments on time, at the end of that time the loan is paid off.

[00:05:12] Basically the amount you borrowed plus the interest you're charged is divided into a set number of payments that you repay over time. Mortgages, car loans and student loans are common examples of installment loans. Installment loans are also sometimes called non-revolving debt.

[00:05:31] These usually show up on your credit report which affects your credit score. Revolving credit. With revolving credit you have a credit limit, that's the max amount you're allowed to borrow at once. Sometimes creditors will charge you a fee for going over that limit if they let

[00:05:48] you do so. You don't have to borrow any or all of it and you can borrow it over and over again as long as you repay it. In short, with revolving credit you can borrow up to a set limit, you only

[00:06:01] have to make minimum monthly payments and there's no set date where you have to pay it all off. Credit cards and HELOCs are common examples of revolving debt. Like installment loans these usually show up on your credit report. Charge cards. Charge cards are not very common anymore

[00:06:19] although American Express still offers some. At a glance they may seem similar to credit cards but they're not the same. For one thing you can't carry a balance on a charge card, instead you have to

[00:06:31] pay off everything you borrow in full each month. Charge cards also don't usually have a preset spending limit but no preset spending limit doesn't mean spend as much as you want. You could still get declined for large purchases if the lender doesn't think you'll be good for it.

[00:06:48] So it's a good idea to check with them ahead of time if you're thinking of spending more than usual. And because there's no preset limit charge cards aren't used in figuring out the credit

[00:06:58] utilization ratio part of your credit score. You usually have to have excellent credit to get a charge card. They usually have annual fees, sometimes pretty big ones and often include rewards. Service credit. Service credit is where you're billed for a service after you've already used

[00:07:16] the service. It's due in full each month and you'll very likely get late fees if you don't pay on time and in full. This type of credit isn't normally reported to the credit bureaus unless

[00:07:27] you don't pay it or you're late. Then it's reported as a negative. Some examples of service or open credit are phone bills, water, electric and gas, and gym memberships. The bottom line. While having

[00:07:41] several types of debt or credit can seem confusing the bottom line is to remember that all debt comes with risk. So you need to be sure you're okay with the risk if you borrow and can't repay it

[00:07:53] as well as the cost fees and repayment rules. There are some types of debt that should be avoided if at all possible. Payday loans and car title loans are especially bad. The same is true for anything

[00:08:06] that can end up with a lien on your property like unpaid taxes or casino loans. And again at the most basic level the two main types of debt are unsecured debt and secured debt. On a similar note

[00:08:19] while there are four types of credit the two you're likely to care about are installment and revolving. That's because they affect your mix of credit which makes up part of your credit score.

[00:08:33] You just listen to the post titled The Types of Debt Explained by Jackie Beck of JackieBeck.com. In general I really try to avoid taking on debt but I also recognize that there are strategic ways

[00:08:47] to use debt when building wealth. For example taking on student loan debt for education could make sense if you have confidence that the earning potential of your career will provide a good return on investment. Same thing with mortgage debt for real estate investors. One of my good

[00:09:04] friends is an investor with a million dollars of mortgage debt but the rental income she's collecting more than justifies it. I think the exception is credit card debt. I've learned the hard way

[00:09:17] that credit card debt should be avoided like the plague. The point is when taking on debt I think it's important to be strategic. I'll give you an example. I had a good experience in leveraging

[00:09:28] low interest debt when I bought my house. I had the 20% down payment but it was pretty much all the cash I had on hand and I didn't want to part with all of it for obvious reasons. So what I

[00:09:40] ended up doing was finding a bank that let me pay half my down payment with a HELOC or a home equity line of credit and I did the math to see how fast I could pay that off and how much I would pay in

[00:09:51] interest. And I did this because I really wanted to avoid PMI insurance. I ended up paying off that HELOC in six months and I only paid around $200 in interest. It was totally worth it for the peace of

[00:10:06] mind. So that being said, all debt isn't horrible as long as you have a plan for repayment and you understand the impact of interest. That should do it for another edition of Optimal Finance Daily.

[00:10:18] Have a great rest of your day and I'll see you on the Wednesday show tomorrow where your optimal life awaits.