Money Mastery Coaching

Types of Debt: The Basics

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What is up everyone? It’s Wade Reed, founder of Money Mastery Coaching, here with another knowledge bomb for you. Many of you have questions about loans, about debts. What are they? Are there good debts, bad debts, what type of debts are there? I want to talk about some of the basics today. So let’s look at this on a whiteboard and let’s talk it through.

Secured Loans

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Digital whiteboard showing connection between secured loans and lenders

Okay. So you should have on the screen here 2 types of debt secured and unsecured, and on the left-hand side. You see, home and car. Those are the 2 most common types of secured debt. Debts that have items attached to them like a home or a car make it lower risk for a lender. And what they do is they create a connection between the item and the lender called a lien. And if you don’t have your title in your home office in a folder somewhere, then that means that you have a lien on your vehicle or your home.

These liens give certain rights to the lender. If you don’t make payments, if you don’t meet the promises that you made in your promissory note, which is typically to make payment at a specified period of time in a specified amount, and you haven’t done that for a certain period of time, usually several months, then the lender has the right to seek legal action to take away from you the home or the car. They can then sell that home, typically at an auction, and get enough that they can be made whole. Whatever loan balance you haven’t paid back yet they get to receive from the sale of the property. If it happens to be sold for more than what they needed to get back, then you get the difference.

So lenders protect themselves through liens, and they’re willing to give lower interest rates when you borrow with things attached to them.

Unsecured Loans

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These are things primarily like credit cards, hospital bills, and personal loans. This could be friends or family. This could also be at a bank. It might be your overdraft line of credit. Many people at banks have overdraft lines of credit. You might be charged a small interest rate, 5-10% for going over the amount you have in your checking account, versus an overdraft fee that could cost you $35 per item.

Digital whiteboard showing types of unsecured debts

So these things are independent of the transaction. These are lenders who, if you use the offerings that they have, they can’t attach it to anything. There’s no physical item that’s of worth. Credit cards are typically for groceries. Hospital bills, for example, my son broke his arm recently. They can’t take his arm, they can’t take his body. They just have to perform the services and if I don’t pay then I can get on some sort of payment plan with them. Personal loans can be for anything. You can ask for a personal loan, you don’t have to disclose what you’re looking for. As long as you qualify under the standards of the bank, then you can get a personal loan. Overdraft lines of credit you typically have to apply for, but again it’s just if you happen to go over your balance on your checking account.

Differences in Interest Rate

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So what are the cost differences? A home loan might be somewhere between 6-8% today. A car loan, probably 8-10% today.

Credit cards are somewhere in the 25-35%. Hospital bills are often 0-10%. Personal loans are often 10-15%. And overdrafts are often in that 10-15% range as well.

Digital whiteboard showing interest rate differences between secured and unsecured debts

So notice the interest cost difference is significant. This is because of perceived risk.

So whenever we’re dealing with debt, we want to understand. Is this a secured or unsecured loan? And what are the requirements that I have to meet in order to stay in good standing with my lender?

Debt as a Tool

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Lenders are partners. I want you to actually have a positive light on debt. Debt can be a great tool to help us acquire things that we need for our families. The house that I sit in right now has a mortgage. I have 100% ownership of this house. I just have a partnership with the lender in terms of them funding the necessary acquisition cost. So I pay an interest to my lender gladly, because they provided for me a sum of several hundred thousand dollars to get into the house and provide it for my family.

My cars are paid for, but I’ve had loans on them in the past, and I’m really grateful for that, because it allowed for me to keep more cash in the bank that I could use for other important things, such as emergency savings, or an opportunity to invest in something else like the business that I run. And I’ve had lower costs because of that.

On the unsecured side, I like credit cards for the convenience of transaction, and having them send me a bill once a month that I pay off. And I always do that. I get points, and I take my family on fun trips because of the points that I acquire. Those can be really convenient things.

But they can be very, very costly if we’re not managing it properly if we don’t know what we’re spending and how to manage that.

So let’s wrap up with those 2 things today. More on debts to come. If you have questions about it, we can deal with that. Let me know in the comments what else you’d like to know about debts, and we’ll talk it through.

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We do not assume any responsibility for errors, omissions, or inaccuracies in the content, nor for any actions taken based on the information provided on this website.

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