Understanding Debt

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Table of Contents

1. What is Credit and What is Debt?2. Using Credit: The Rewards & Risks 3. Four Types of Debt 4. The Cost of Using Credit5. Running the Numbers

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What is Credit and What is Debt? Credit means a lender is willing to loan you

money – called principal – in exchange for your promise to repay it, usually with interest.

Interest is the amount you pay to buy something on credit. The higher the interest rate, the higher your monthly payments.

Debt is how much you owe the lender, including all interest and fees. These lenders have legal claims against your future income should you not be able to repay a debt.

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Using Credit: The Rewards & Risks

The Rewards Convenience Protection Emergencies Opportunity to Build

Credit Special Offers and

Bonuses

The Risks Interest Fees Overspending Debt

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Four Types of Debt

There are 4 main types of debt:1. Credit Cards2. Student Loans3. Installment Loans4. Mortgages

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Credit Cards

Credit Cards No payoff deadline. Monthly minimum payments vary

depending on the balance and Annual Percentage Rate (APR), either a fixed or variable rate.

Usually has the highest interest rate of these four types of debt.

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Student Loans

Student Loans Used for educational expenses. Some programs offer deferred payments

until after graduation. Loan term is usually up to 10 years, and

monthly payments are adjusted annually when interest rates are adjusted.

May provide an income tax break on interest paid to the lender.

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Installment Loans

 Installment Loans Typically used for large purchases, i.e.,

cars or appliances. Loan terms can vary from a few months

to several years. Monthly payment amounts are set for

the life of the loan.

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Mortgages

Mortgages Used specifically to purchase real estate. Loan terms vary, and payments may be

set for the life of the loan (fixed rate) or may change more frequently (adjustable rate).

May provide an income tax break on interest paid to the lender.

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The Cost of Using Credit

Unsecured Loans Annual Fee: Yearly fee for having credit available. Credit Limit: Maximum amount of credit a lender

will extend. Over Limit Fee: Fee/penalty for going over your

credit limit. Grace Period: Length of time before you

accumulate interest. Finance Charge: Monthly fee for maintaining a

balance. Late Fee: Fee/penalty for not making a payment on

time.

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The Cost of Using Credit (Con’t)

Secured Loans Loan Term: Length of time you have to

pay off the loan. Origination Fee: Charge for setting up

the loan (usually for mortgages). Grace Period: Length of time to make

payment for a late fee is assessed.

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The Cost of Using Credit (Con’t)

There is no federal limit on the interest rate a credit card company can charge.

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The Cost of Using Credit (Con’t)

Universal Default: A practice, especially in the credit card industry, where lenders agree to change the terms of a loan from the normal terms to the default terms, when they are informed that their customer has defaulted with another lender or has generally taken on too much risk. This means a lender may increase your rates even if you have never paid late with this lender.

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Running the Numbers

Let’s say you want to purchase a car for $7,500. You put $1,500 down and need to borrow $6,000.

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Running the Numbers (Con’t)

Let’s say you want to purchase a $2,000 flat screen TV on your new credit card.

If you pay the minimum every month, how long will it take to pay off this debt? MORE THAN 30 YEARS, and you will pay almost $5,000 in interest!

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Summary

Making purchases on credit has rewards and risks.

Credit offers convenience and protection in emergencies.

Borrowing money costs money and can result in debt.

Use credit wisely and manage debt responsibly. Be aware of credit terms and fees, and read

the disclosures carefully. Run the numbers before making large

purchases.

Thank you!

For more info, please visit financialfitnessassociation.org.