Alright, gather round. This is going to be important.
Setting the scene
As you’ve probably noticed, money is a bit complicated to manage, at least at first. You get the hang of it pretty quickly though, and in no time you’re saving for large purchases, monitoring your spending and income, and socking away the savings you don’t need at the moment in accounts that allow your money to make money for you.
You have a bit of a problem though. You’ve been working hard and just got offered a good job that should increase your income by quite a bit! The only problem is that the new job is two states away and would need you to move. You’ve been doing well saving for bigger expenses like a new couch or TV, but nothing as expensive as a multi-state move! What can you do?
I mean, I guess I’d have to give up the job offer. I can’t move if I can’t afford it.
Actually, believe it or not, in cases like these it may make more sense to take out some form of debt to fund the move!
Nope, no way. I’ve seen way too many people get burned by debt. It’s all “free money” until the bill comes due.
In many cases, you’re right. Debt can be a way to spend money you don’t have on things you don’t need. And it’s all fun and games until you hit the limit on your debt and have to start paying it back (or go bankrupt if you can’t). In some cases though, debt can be a way to multiply your investments, so don’t shy away from all debt completely.
We’ll go more into all that in a future post. For now, let’s back up and talk about what debt actually is.
What exactly is debt?
Believe it or not, this one is pretty straightforward, although debt can crop up in places where you might not expect it.
Is it literally just owing money to someone else?
Actually, yes! Debt is just money you took from someone else and promised to pay back later.
I’m guessing it gets more complicated when we talk about what kinds of debt there are?
Bingo. The devil’s in the details, as they say.
What is revolving debt?
The most common kind of debt most people run into is credit card debt. It’s called “credit card” debt, although the “card” isn’t really necessary to use this type of debt. In general, this type of debt is more accurately called “revolving” debt.
What makes credit card debt “revolve”?
“Revolving debt” is a bit of a weird name, for sure. This kind of debt “revolves” because the debt isn’t used for a specific purpose, like buying a car, and can be “reused” as many times as you want, as long as you pay off some of the debt first. In this way, the debt is “revolving” as you can get into debt with it and pay it back off, over and over.
Okay, sure. So you can take out as much money as you want, spend it, then repay it and keep doing that over and over.
Exactly, although, usually, revolving credit has a “credit limit” and, once you’ve hit that limit, you can’t borrow any more until you’ve paid some off.
Got it. So there’s revolving debt. What other kinds are there?
What are the other common types of debt?
We’ve covered revolving debt, and that implies there is debt that doesn’t “revolve”. Said another way, you’re given credit to use for a specific purpose and you can’t reuse the credit once the debt is paid off. Think car loans, home mortgages, and installment plans for things like landscaping projects. When these types of debts are paid off, you can’t reuse the credit; it’s a one-time deal.
So once the car loan is paid off, I can’t use that same loan to get another car.
Right. You’d need to get a brand new loan for a different car. The debt is tied directly to the thing you’re buying with it.
And it’s the same with a mortgage?
Sure is! The mortgage you have on your home is tied to your home and your home only. The mortgage can only be used to buy your home specifically and, once it’s fully repaid, can never be used again.
What about something like student loans? Or medical debt? Those seem to be pretty important to a lot of people.
Good point. Student loans and medical debt are also very common types of debt, although they’re a bit different in their own way. I did say the devil’s in the details!
Let’s start with student loans then.
Sure! Student loans are not revolving credit and they are also not tied to a specific asset, like a car or home. Student loans are used to fund a college or graduate education and typically have different rules about repayment. For example, student loans typically don’t need to be paid back while at school and your monthly repayment is often determined by how much money you make. If you have a higher income, you have to repay more. Lower income, lower repayment. This can be both a very good thing, since it ensures only a (somewhat) manageable part of your income goes to repayment, and a very bad thing as you may not be making large enough payments month-to-month to actually pay off your loans on time.
Wait, so your loan might never get paid off? What do people do with these loans??
Basically they repay them forever. The debt will sometimes get forgiven by the government or through special programs, but yeah, for people stuck in this trap, they just have these loans forever. Sometimes more than 25 years.
That’s wild. At least they got an education I suppose? And what about medical debt?
Medical debt is interesting because it is, like student loans, not tied to a specific asset like a car or home and cannot be reused or “revolved” like credit cards. The weird thing with medical debt is that, unlike other forms of debt, it doesn’t usually have a set repayment plan built-in. Instead, most medical debt is issued as a one-time repayment; the full bill comes due all at once.
What?? So how do people pay??
Well, that’s complicated, but many people simply go bankrupt because of medical debt. In fact, something like 67% of all bankruptcies in the United States are due mostly to medical debt. That’s one way out of it. It’s not a good way, but it’s a common way.
Besides that, some negotiation with the issuer of the debt (e.g., the hospital, doctor, clinic) is usually possible, especially if the debt is owed to a hospital. Many hospitals are willing to forgive some of the debt outright or agree to a repayment plan, so people can pay it back over time. Make no mistake though, medical debt is tough to deal with. On top of that, you usually get into medical debt because of something bad happening to you that you can’t control, so it’s a double whammy.
That’s the worst part. It’s not like someone running up a credit card bill because they like buying expensive TVs. It’s usually not your fault you get sick or hurt and fall into medical debt.
Indeed. But that’s a problem that requires a political solution and this is not a political blog.
Right, right. Honestly, though, this whole debt thing still sounds scary. Is there really such a thing as good debt?
Indeed, there is. More on that in the next post though.
Thanks for reading.
Common Cents 