Understanding the Main Types of Debt and How to Pay Them Off
Debt represents one of the biggest challenges Americans face. Although some types of debt, such as mortgages and student loans, can help you build wealth by buying property or qualifying for high-paying work, even so-called "good debt" can become overwhelming if you're unable to make your monthly payments.
If you're struggling under the weight of your debt, there are steps you can take to make your payments more manageable, get out from under your bills once and for all, and improve your credit score. Paying off debt takes patience and time, particularly if you have high credit card and loan balances. This guide will help you understand your debts and develop a plan for becoming debt-free.
What Is Debt?
Debt essentially refers to money you’ve borrowed and now owe to a lender. There are different types of debt, but most debt falls into a few key categories: secured, unsecured, revolving, non-revolving and corporate. It’s essential to know exactly which types of debt you have and how you can pay off your creditors.
Good vs. Bad Debt
Good debt typically refers to mortgages and student loans, which can help you build wealth and improve your overall financial profile. Buying a property increases your assets, and paying for a college education can open doors to well-paying career opportunities. On the other hand, bad debt typically refers to credit cards or other high-interest loans that don't help you build wealth and can cause you to overextend your finances.
Types of Debt
There are several different types of debt, and knowing which category your debts fall into can help you create a path toward paying off your accounts. Your options will vary based on the type and amount of debt you owe.
Secured debt is tied to an asset, such as your home or car. With a secured debt, lenders can repossess the property if you default on your loan, which is why interest rates for these types of loans tend to be lower than with unsecured debts. Lenders take on less risk if they have the right to reclaim and resell the property in cases of non-payment.
According to Experian, this type of debt is quite common in the U.S. Roughly 44% of American consumers hold a mortgage. And if you're making car payments every month, you're not alone. As of 2019, car loan debt is at an all-time high, with the average auto loan debt coming in at more than $19,000.
One way to make paying off secured debt more manageable is through refinancing. By taking out a new loan with a lower interest rate, you may be able to reduce your monthly payments and extend your repayment timeline.
Resources to Help With Secured Debts
These resources offer an in-depth look at different ways to attack secured debts. If you’re not sure which is best for you, it’s never a bad idea to contact lenders or credit counselors who can review your options and help you decide what will work best in your case.
- Buying a Home After Bankruptcy, Foreclosure or Short Sale: Bankruptcy doesn’t bar you from qualifying for a mortgage in the future. In fact, you may be able to buy a home in as little as a year following bankruptcy.
- Debt-to-Income Ratio Calculator: Your debt-to-income ratio plays a major role in whether you will qualify for a mortgage, as well as your mortgage amount and interest rate. Knowing your DTI can help you gauge your borrowing ability and help you understand how much debt you need to pay down before you apply.
- Fighting Foreclosure – Rights, Strategies & Resources for Protecting Your Home: Foreclosures may seem frightening, but you still have options. Your lender may be willing to give you a forbearance so you can catch up on payments, or they may allow for a short sale of your home. A short sale occurs when you sell your house for less than what you owe on it.
- Refinancing With Bad Credit: Even with bad credit, you may be able to qualify for refinance loans that will lower your monthly payments and work better with your budget.
- Reverse Mortgages: If you're 62 or older and have significant equity in your house, you might consider a reverse mortgage. You will be borrowing against the equity you've built up, and you won't have to make payments until you move out of the home.
- Auto Loan Calculator: Before you buy, it helps to run the numbers on how much you’ll pay each month on different loan amounts. That way, you can narrow your car search to vehicles that are within a comfortable price range.
- Auto Loan Refinancing – Learn How & When a New Loan Can Lower Your Car Payments: If your auto loan is taking up too much of your income, refinancing to a new loan can lower your monthly payments and free up some of your cash each month.
- Bad Credit Car Loans – What to Do When You Need a Car but Have Poor Credit: If you have bad credit but need a car, you may qualify by applying for a loan with a co-signer or settling for less expensive models.
Unsecured debt refers to credit cards, personal loans, student loans or other types of loans that are not tied to property or other assets. Generally speaking, unsecured debts have higher interest rates since they represent a greater risk for lenders.
Credit card debt is a leading type of unsecured debt in the U.S. The average credit card balance was $5,315 in 2020, though that number varies widely by consumer and location. According to the Chamber of Commerce, Alaskans had the highest average credit card debt of $10,685 in 2019. Virginians and Texans also saw high average balances of $9,100 or more.
However, many people carry much higher unsecured debt loads in the form of student loans or medical debt.
Resources to Help With Unsecured Debts
The resources listed below can help you strategize how to pay off debt such as credit cards, personal loans and medical bills.
- Balance Transfer Credit Cards – How Transferring Your Debt May Help You Meet Your Financial Goals: By transferring a high-interest balance onto a new card with a 0% interest introductory period, you can save money on interest and pay your principal down faster.
- COVID-19 Debt and Credit Card Relief: If your finances suffered during COVID-19, there is hope. This guide breaks down the steps you can take to maintain control of your credit amidst the chaos caused by the pandemic.
- Credit Card Debt-Free – How to Face Facts, Save Money and Get that Balance Paid: The first step toward paying off credit card debt is creating a plan for how to do it. Having a clear strategy can help you stay focused and make more than your monthly minimums to get out of debt quickly.
- The Ultimate Guide on How to Improve Your Credit Score: Your credit score affects your financial options, whether that’s opening a new credit card or buying a home. This guide walks you through what you can start doing now to raise your score and expand your financial horizons.
- Your Annual Credit Report – When to Get It and How to Read It: Federal law entitles you to a copy of each of your credit reports (from Experian, TransUnion and Equifax) each year. Reviewing your reports can help you understand what lenders see when you apply for financing, as well as identify potential signs of fraud.
- How to Get Out of Medical Debt: Medical debt can create extreme financial hardships, driving people to bankruptcy and deep distress. However, there are options for coping, and this article helps you understand what you can do to ease this burden.
- Managing Finances and Covering the Mortgage During Cancer Treatment: A cancer diagnosis is daunting enough without worrying about how you’ll manage your mortgage payments and cover treatments. Learn what to consider and what questions to ask about how far your insurance will go during this challenging time.
- A Guide for College Students – How to Get A Degree Without Debt: Although attending college or university can be costly, there are ways to do so without incurring debt. Think grants and scholarships, crowdfunding, employer reimbursement and work-study programs.
- Student Loan Forgiveness and Cancellation: You may be able to offload student debt through forgiveness or cancellation, depending on a number of factors related to your field of work and where you went to school.
- Ultimate Guide to Paying Down Student Loan Debt: Getting a clear understanding of the type of loans you have and how much you owe will help you zero in on your repayment options and make progress on your student loans.
A revolving line of credit is something you leave open indefinitely and can use and then pay down many times. Home equity lines of credit, personal lines of credit and credit cards are examples of revolving debts.
A HELOC can be particularly attractive if you have equity built up in your home and need money to cover big expenses. However, it can create financial hardship if your line of credit has a variable interest rate that increases to a point where you can no longer afford the payments or can only afford the minimums.
During the coronavirus pandemic, some lenders restricted their HELOC lending even to borrowers who had substantial equity in their homes, according to The Washington Post. The uncertainty surrounding the economy made some companies warier about giving revolving credit lines to people who seemed high-risk despite their properties' value.
Resources to Help With Revolving Debts
Need help managing your revolving debt? These articles include insights and actionable tips for taking back control of your money.
- Home Equity Lines of Credit – Insider Advice on How to Apply for and Use HELOCs: Learn how HELOCs work and get advice from banking professionals on the best way to use these powerful financial tools.
Non-revolving debt is a one-time debt. A car loan, personal loan or home equity loan (not to be confused with HELOCs) are examples of non-revolving debts. You apply for them, receive the funds and then make monthly payments until the debt is paid off. If you still need access to cash, you'll have to apply for a new loan altogether. Non-revolving debts may be secured or unsecured loans.
Resources to Help With Non-Revolving Debts
The following links include resources to better understand your options around obtaining non-revolving financing and successfully managing that debt.
- Can I Get a Car Loan If I am Unemployed or Furloughed?: Being between jobs can make it more difficult to get a car loan. But there are ways to manage, such as getting a co-signer or saving money for a large down payment. However, it’s crucial that you not borrow more than you can afford to repay, particularly before you’ve started working steadily again.
- Guide to Home Equity Loans – Pros & Cons, Requirements & Limits: Loans using your home equity as collateral can provide flexibility when you have big-ticket expenses to pay for, such as home renovations or your child's college tuition. But there are drawbacks, and it's important to see the full picture before deciding whether to use them.
- How to Choose a Student Loan: Not all loans are created equal, especially when it comes to repayment and forgiveness options.
- Who Student Loan Debt Impacts the Most: Some student loan holders, such as people with disabilities, women and people of color, struggle more with debt than other groups. But depending on your circumstances, there may be options for student debt relief.
If you’re a small business owner, you might have secured debt related to your company. Perhaps you have a mortgage on a commercial property, or you’ve purchased a vehicle with company funds. As with personal mortgages and auto loans, these loans are backed by the business’s assets.
The Small Business Administration (SBA) guarantees certain loans for entrepreneurs, making lenders more willing to work with new companies.
Resources to Help With Corporate Debt
Understanding corporate debt can be challenging. These resources can help you make sense of the options available to you.
- Business Loans: A variety of business loans are available for entrepreneurs and owners. Search for the right business loan based on your company type and specific needs.
- Merchant Cash Advance for Business – Getting Quick Financing When You Need to Make Ends Meet: Merchant cash advances can help with your company’s cash flow, particularly if your clients pay on long invoice cycles or you’re just getting the business off the ground.
- Small Business Administration Loans – How to Secure Financing Through a Government Guarantor: SBA loans can help kickstart your company’s growth, but it’s important to apply for the right kind and ensure that you’re prepared to make a good impression.
Other Debt Types
When people are strapped for cash and need money quickly, they may think they have no other choice than to take out payday loans. These are short-term loans that borrowers agree to pay back when their next paycheck comes through. However, payday loans typically carry extremely high-interest rates. Lenders often allow borrowers to roll the loans over, meaning that they extend the repayment period, during which even more interest accrues. Additionally, interest rates can be well over 100% of the loan principal, making these debts extremely expensive.
Some states cap the amount of interest payday lenders can charge to protect borrowers from accumulating more debt than they can afford.
Resources to Help With Other Debts
Debt can be stressful under regular circumstances, but it becomes especially difficult to deal with if you’ve inadvertently become involved with a scam company or predatory lenders. These guides will help you steer clear of such traps and figure out what to do if you’ve been a victim of predatory companies.
- Avoiding Mortgage Fraud: This article breaks down how to spot different types of mortgage fraud before you borrow and if you’re facing foreclosure.
- How to Pay off Debt in Collections: You can find help to pay off your debts in collections in this resource guide with a step-by-step plan. This article also provides ways to negotiate with debt collectors, identify collection scams and what to do if the debt is not yours.
- Debtor's Rights – A Look at Your Protections and What Creditors Can and Can't Do: Knowing your rights will help you defend yourself against predatory collections practices and develop plans to pay off your debts as quickly as possible.
- Unfair Student Loan Practices: It’s important to be informed about what student loan creditors and their collectors are allowed to do and how you can protect yourself from scams and underhanded practices.
Coping With Debt: Support and Resources
Financial stress can wreak havoc on both your mental and physical well-being. In addition to causing anxiety and depression, the American Psychological Association reports that chronic money worries can lead to heart disease and diabetes as well. While getting your finances on track is important for economic stability, it’s crucial that you prioritize your health, no matter where you are in your debt journey.
Mental and Physical Support Resources
- Addressing Disparities in Finance for Hispanics & Latinos: Hispanic and Latino communities in the U.S. face substantial challenges to building wealth and economic stability for their families. This guide offers a path forward.
- Student Loan Stress & Mental Health: Recognize the Signs & Get Help: Feeling overwhelmed by student debt can lead to anxiety, depression, substance abuse and obsessive-compulsive disorder. Recognizing student loan stress symptoms is the first step toward getting the help you need to cope.
- Tackling Disparities in Finance for Black and African Americans: Find context for the historical barriers Black and African Americans have faced when it comes to economic resources, as well as insights on how to combat those difficulties.
- How Debt and Financial Stress Affects Your Mental Health and Ways to Cope: Paying off debt can be a long-term endeavor if you have steep high-interest balances. But it’s important to keep things in perspective and take care of your health.
- Guide to Debt Reduction – 5 Options to Resolve Debt Distress: You don’t have to manage debt alone. Credit counseling, refinancing and bankruptcy may be options available to you, and some experts can walk you through each of these processes.
- Should You Pay Down Debt or Save During COVID-19?: Financial decisions feel more consequential during the pandemic. This article will help you make sense of the right money moves for you.
- Strategies to Negotiate and Pay Bills During COVID-19: You may be able to lower your medical debt and other bills by negotiating directly with your hospital, medical care provider or lenders. They may also have payment plan options or relief programs for low-income patients and borrowers.
- 12 Ways to Get Out of Debt Faster: If you find it difficult to pay off your debts, you might consider taking out a debt consolidation loan or talking to lenders to negotiate your payments, so they fit within your monthly budget.
- Bankruptcy as Debt Relief: If you cannot pay your bills and meet your monthly living expenses, then bankruptcy may provide financial relief by allowing you to discharge some or all of your debts.
- Business Bankruptcy – How Chapter 11 Can Help: Chapter 11 bankruptcy enables businesses to restructure their debts while they continue operating.
- The Chapter 7 vs. Chapter 13 Bankruptcy Question: Learn the difference between these two types of personal bankruptcy filings and which one might apply to your situation.
Expert Insight on Coping With Debt
MoneyGeek spoke with several personal finance experts, including university professors, about how consumers can chart a course out of debt. They shared their insights on debt reduction strategies, tackling debt while in a low-income job and avoiding taking on more debt in the future.
- What behaviors can consumers adopt, regardless of their debt loads or socioeconomic circumstances, to begin alleviating their debts?
- If someone is in a low-income job and feels trapped in a debt cycle, what might a path out of that situation look like?
- What are the best steps consumers can take to reduce their dependence on debt and avoid accumulating high debt in emergencies or other unexpected situations?
- If a consumer decides to pursue debt consolidation, credit counseling or bankruptcy, what should they look for in the companies and professionals they hire to help them? What are some red flags vs. signs of trustworthiness and effectiveness?
Professor of Economics at Texas A&M University
Associate Professor at the Graham School of Management
Founder of The Ways to Wealth.
Partner and Bankruptcy Lawyer at Rollins Law Firm