Types of Debt

With consumer debt rising and savings rates falling, most Americans owe something. But when it comes to debt, not every type is equal. There are many types of debt, and figuring out what it all means can be confusing for the average person. Yet not knowing can cost you dearly: lenders look at the types of debt you carry as well as how much debt you have and how reliably you make your payments. If they don’t like what they see, they’re able to hike your interest rates or offer you their less-desirable terms. Knowing the different types of debt-and which types you carry-can help you make yourself more attractive to lenders.

1. Unsecured vs. Secured Debt. The terms “unsecured” and “secured” refer to whether the lender has some type of collateral they are able to collect if the debt is not paid off. A mortgage is a type of secured debt: if you don’t pay, the lender can take your home. In contrast, a credit card balance is usually unsecured, meaning that the issuer cannot come into your house and take property if the payments are not made (except in some rare cases). All other things equal, unsecured debt is usually better than secured debt for the borrower.

2. Revolving vs. Installment Debt. Looking at the above example, it may seem like credit card debt is more favorable than mortgage debt. However, that’s not the case. One of the reasons mortgage debt is better is because it’s defined as an installment loan. This means that it is a one-time loan that’s divided into fixed monthly payments. On the other hand, credit card debt is revolving, meaning that the monthly payment changes from month to month. Revolving credit also often offers the opportunity to rack up more debt by charging more after the initial purchase. In other words, even if you have a balance on your credit cards, you can continue to charge more. Often, revolving debt has a higher interest rate than installment loans. Further, lenders see installment loans as better than revolving loans, and will often give better terms to borrowers with more installment loans and less revolving debt, assuming that the debt-to-credit ratio and history of repayment are equal.

3. Store vs. Bank Credit Cards. Taking out a credit card at your favorite store is the same as having a credit card from a bank, right? After all, they both have the MasterCard logo (or Visa) and they’re both credit cards. Believe it or not, all credit cards are not created equal. Even assuming that interest rates are the same-often, store cards have a much higher rate-there’s a difference in the way that lenders view the two types of credit cards. Because store credit is often used by borrowers with less-than-perfect credit (their credit lending criteria are much looser than bank-issued cards), even borrowers with good credit could be hurt by having many store credit cards.

No matter what is in your credit report, the less debt you have, the better off you will be. However, armed with the knowledge of the different types of debt and how they can work for or against you, you can get an idea of how to approach your debt now and in the future.