Different Types of Debt Explained

All debts are not created equal. While borrowing money can be necessary, it’s essential to know that each debt type has its own set of rules. Mixing up different kinds of debt in your credit history can actually be good. It shows you can manage money well. One important thing to know is your ‘credit utilization rate,’ which is a fancy way of saying how much you owe compared to how much credit you have. Ideally, this should be less than 30% of your total credit.

Let’s simplify the main types of debt and what they mean for you:

understanding the different types of debt helps you manage your finances better

Different Types of Debt

1. Credit Card Debt

• What it is: Just like the name suggests, it’s debt from your credit card. The unique thing is, there’s no fixed term to repay, and no property (like a house) backing the loan.
• Interest: Average interest rates on U.S. credit cards hover at about 21% for the most recently reported quarter, which ended in August, compared with about 16% in the year-ago period, according to the U.S. Federal Reserve Board.
• Repayment: At a minimum, you need to pay a small amount monthly. But it’s best to pay more than that, so you don’t drown in interest. Paying the due balance in full is the best way to manage your credit card debt and keep it at a healthy level.
• Tax: No tax benefits here.
• Effect on Credit Score: If you consistently pay your bills, it can boost your credit score. But be cautious about maxing out cards or opening too many.

2. Mortgages

• What it is: Mortgages are installment loans, which means you pay them back in a set number of payments (installments) over an agreed-upon term (usually 15 or 30 years). They’re also secured loans, meaning the home you bought with the mortgage serves as collateral for the debt. If you stop making payments, the lender can begin the foreclosure process. This typically includes seizing the property and selling it to get back its money.
• Interest: This has been a controversial subject in the economic regression post covid everywhere in a the world. The rates are increasing and is recording high levels month after month. Earlier in the year, experts forecasted that the 30-year, fixed-mortgage rate would fall to within the 5% to 6% range in later 2023, though some predicted it might go even higher. Currently, the average 30-year, fixed-rate mortgage is over 7%, reaching 7.79% as of October 26, according to Freddie Mac.
• Repayment: Usually a fixed amount monthly, with terms lasting 15 or 30 years.
• Tax: In general, you can deduct the mortgage interest you paid during the tax year on the first $750,000 of your mortgage debt for your primary home or a second home.
• Effect on Credit Score: Timely payments can give your credit score a lift, and it helps show a mix in your credit types.

3. Auto Loans

• What it is: Like a mortgage, an auto loan is a secured installment loan. It’s paid in a set number of payments over an agreed-upon period of time (often three to six years). If you stop making payments, the lender can repossess your car and sell it to get back its money.
• Interest: According to Experian’s most recent State of the Automotive Finance Market report, the average auto loan interest rates across all credit scores are 6.63% for new cars and 11.38% for used cars. The rate you receive also has a lot to do with your credit score and your loan term.
• Repayment: Fixed monthly amounts over a few years.
• Tax: No tax breaks on car loans.
• Effect on Credit Score: Regular payments can drive up your credit score.

4. Student Loans

• What it is: Loans to cover school costs. They’re flexible in terms of payment and are a type of unsecured installment debt.
• Interest: Rates vary, but remember that interest rates and fees are generally lower for federal student loans than private student loans. As  per Federal Student Loan Aid,

  The interest rate for a federal student loan varies depending on

  • the loan type and

  • the first disbursement date of the loan (for most types of federal student loans).

  The table below provides interest rates for Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans first disbursed on or after July 1, 2023, and before July 1, 2024.

  Perkins Loans (regardless of the first disbursement date) have a fixed interest rate of 5%.

  Interest Rates for Direct Loans First Disbursed on or After July 1, 2023, and Before July 1, 2024

  Loan Type	Borrower Type	Fixed Interest Rate
  Direct Subsidized Loans and Direct Unsubsidized Loans	Undergraduate	5.50%
  Direct Unsubsidized Loans	Graduate or Professional	7.05%
  Direct PLUS Loans	Parents and Graduate or Professional Students	8.05%

  All interest rates shown in the chart above are fixed rates. A fixed rate will not change for the life of the loan.

• Repayment: Typically, you’d pay them off in 10 years. But sometimes, you can pay based on your income.
• Tax: At the end of each year, your servicer will send you Form 1098-E by mail or electronically. This form details how much interest you have paid on your student loan during the year. You can deduct up to $2,500 in annual interest on your tax return, subject to income limitations and other restrictions.
• Effect on Credit Score: Great starter debt. Paying on time can be a good starting point for credit history.

5. Medical Debt

• What it is: When you can’t pay your medical bills in full. These are essentially payment plans you set up with your health care providers billing department.
• Repayment: Usually, doctors or hospitals would like full payment. But if it’s too much, you can usually negotiate.
• Tax: If you itemize your deductions for a taxable year on Schedule A (Form 1040), Itemized Deductions, you may be able to deduct the medical and dental expenses you paid for yourself, your spouse, and your dependents during the taxable year to the extent these expenses exceed 7.5% of your adjusted gross income for the year.
• Effect on Credit Score: When medical debt ends up in collections, it could hurt your credit scores. And if you use a credit card to pay your medical bills, there could be an impact as well. Medical debt that’s already been paid off is not included in credit reports.

Bottom Line…

When you are juggling your personal finances you are likely juggling different types of debt.  Whatever kind of debt you have, always aim to pay on time. Regular payments keep debt collectors at bay and ensure your credit score stays healthy. Staying focused on your debt to income ratio, and also having the right balance of good credit in your finances can ensure a healthy personal finance journey.

If you’re struggling to pay off debt, ACCC can help. Schedule a free credit counseling session with us today.