Debt Basics

When dealing with debt, it’s important to recognize that there are various types and they won’t always result in the same outcome. For example, going into debt for school or business purposes or taking out a mortgage to buy a home could be considered investments that might yield greater financial earnings for you in the future. This kind of debt may be costly in the short term but could potentially end up paying for itself in the long term if it’s an investment in an asset such as education or real estate. However, debt that isn’t likely to make a future return is simply a financial burden in both the short term and the long term. This is the kind of debt that must be managed carefully to avoid letting it quickly spiral out of control.

No matter how much or what kind of debt you take on, it’s essential to have a solid repayment plan. Since most interest on debt compounds over time – that means owing interest on the interest applied to the loan – a small amount borrowed can quickly increase. When handling debt, it’s best to pay it back as quickly as possible.

The 28/36 Rule
One helpful guide is a formula that some mortgage lenders use: the 28/36 rule. It stipulates that your housing payments shouldn't exceed 28 percent of your gross monthly income, while your total debt service — including your house payments, utilities, credit cards and other loans — shouldn't be more than 36 percent.

Types of Loans

• Student Loans – If you need to borrow money to cover education, especially higher education, student loans are a common option in many places. Typically there will be a few options, sometimes including government or loans from private companies. 
  

• Mortgage Loans – Buying a home can often require applying for a mortgage loan. Different interest rates and repayment times can greatly affect a mortgage loan’s impact on your finances. 
  

• Vehicle Loans – You can buy and finance a car through vehicle loans from car dealerships, banks, and credit unions. You may also take out a home equity loan, which allows you to use your home as collateral for your vehicle loan. 
  

• Personal Loans – A personal loan can be used to cover various costs, from repaying credit card debt to taking an expensive vacation, at your discretion. Personal loans can be secured or unsecured, depending on whether you have collateral and the risk you want to take. 
  

• Peer-to-peer Loans – You can use an online service to match up with a peer lender, whether you want a loan for personal purposes or your business. Many of these loans are unsecured, and since operations are normally conducted entirely online you should approach peer-to-peer loans with caution.