Debt comes in all shapes and sizes. You can owe money to utility companies, banks, credit card providers, and the government. There’s student loan debt, credit card debt, mortgage debt, and much more. But what are the official categories of debt and how do the payoff strategies for these debts differ?
Categories of Debt
Debt is generally categorized into two simple forms: Secured and Unsecured. The former is secured against an asset, such as a car or loan, and means the lender can seize the asset if you fail to meet your obligations. Unsecured is not secured against anything, reducing the creditor’s control and limiting their options if the repayment terms are not met.
A secured debt provides the lender with some assurances and collateral, which means they are often prepared to provide better interest rates and terms. This is one of the reasons you’re charged astronomical rates for credit cards and short-term loans but are generally offered very favorable rates for home loans and car loans.
If the debtor fails to make payments on an unsecured debt, such as a credit card, then the debtor may file a judgment with the courts or sell it to a collection agency. In the first instance, it’s a lot of hassle without any guarantee. In the second, they’re selling the debts for cents on the dollar and losing a lot of money. In either case, it’s not ideal, and to offset this they charge much higher interest rates and these rates climb for debtors with a poorer track record.
There is also something known as revolving debt, which can be both unsecured and secured. Revolving debt is anything that offers a continuous cycle of credit and repayment, such as a credit card or a home equity line of credit.
Mortgages and federal student loans may also be grouped into separate debts. In the case of mortgages, these are substantial secured loans that use the purchase as collateral. As for federal student loans, they are provided by the government to fund education. They are unsecured and there are many forgiveness programs and options to clear them before the repayment date.
What is a Collection Account?
As discussed above, if payments are missed for several months then the account may be sold to a debt collection agency. This agency will then assume control of the debt, contacting the debtor to try and settle for as much as they can. At this point, the debt can often be settled for a fraction of the amount, as the collection agency likely bought it very cheaply and will make a profit even if it is sold for 30% of its original balance.
Debt collectors are persistent as that’s their job. They will do everything in their power to collect, whether that means contacting you at work or contacting your family. There are cases when they are not allowed to do this, but in the first instance, they can, especially if they’re using these methods to track you down and they don’t discuss your debts with anyone else.
No one wants the debt collectors after them, but generally, you have more power than they do and unless they sue you, there’s very little they can do. If this happens to you, we recommend discussing the debts with them and trying to come to an arrangement. Assuming, that is, the debt has not passed the statute of limitations. If it has, then negotiating with them could invalidate that and make you legally responsible for the debt all over again.
Take a look at our guide to the statute of limitations in your state to learn more.
As scary as it can be to have an account in collections, it’s also common. A few years ago, a study found that there are over 70 million accounts in collections, with an average balance of just over $5,000.
Can Bankruptcy Discharge all Debts?
Bankruptcy can help you if you have more debts than you can repay. But it’s not as all-encompassing as many debtors believe.
Chapter 7 bankruptcy will discharge most of your debts, but it won’t touch child support, alimony or tax debt. It also won’t help you with secured debts as the lender will simply repossess or foreclose, taking back their money by cashing in the collateral. Chapter 13 bankruptcy works a little differently and is geared towards repayment as opposed to discharge. You get to keep more of your assets and in exchange you agree to a payment plan that repays your creditors over 3 to 5 years.
However, as with Chapter 7, you can’t clear tax debts and you will still need to pay child support and alimony. Most debts, including private student loans, credit card debt, and unsecured loan debt will be discharged with bankruptcy.
Bankruptcy can seriously reduce your credit score in the short term and can remain on your credit report for up to 10 years, so it’s not something to be taken lightly. Your case will also be dismissed if you can’t show that you have exhausted all other options.
Differences in Reducing Each Type of Debt
The United States has some of the highest consumer debt in the world. It has become a common part of modern life, but at the same time, we have better options for credit and debt relief, which helps to balance things out a little. Some of the debt relief options at your disposal have been discussed below in relation to each particular type of long-term debt.
The Best Methods for Reducing Loans
If you’re struggling with high-interest loans, debt consolidation can help. A debt consolidation company will provide you with a loan large enough to cover all your debts and in return, they will give you a single long-term debt. This will often have a smaller interest rate and a lower monthly payment, but the term will be much longer, which means you’ll pay much more interest overall.
Debt management works in a similar way, only you work directly with a credit union or credit counseling agency and they do all the work for you, before accepting your money and then distributing it to your creditors.
Both forms of debt relief can also help with other unsecured debts. They bring down your debt-to-income ratio, leave you with more disposable income, and allow you to restructure your finances and get your life back on track.
The Best Methods for Reducing Credit Cards
Debt settlement is the ultimate debt relief option and can help you clear all unsecured debt, with many companies specializing in credit card debt.
Debt settlement works best when you have lots of derogatory marks and collections, as this is when creditors are more likely to settle. They can negotiate with your creditors for you and clear your debts by an average of 40% to 60%. You just need to pay the full settlement amount and the debt will clear, with the debt settlement company not taking their cut until the entire process has been finalized.
A balance transfer can also help with credit card debt. A balance transfer credit card gives you a 0% APR on all transfers for between 6 and 18 months. Simply move all of your credit card balances into a new balance transfer card and then every cent of your monthly payment will go towards the principal.
The Best Methods for Reducing Secured Debts
Secured debt is a different beast, as your lender can seize the asset if they want to. This makes them much less susceptible to settlement offers and refinancing. However, they will still be keen to avoid the costly foreclosure/repossession process, so contact them as soon as you’re struggling and see if they can offer you anything by way of a grace period or reduced payment.
Most lenders have some form of hardship program and are willing to be flexible if it increases their chances of being repaid in full.