Debt | Definition

Debt can have its benefits in acquiring appreciating assets like a house. However, if debt is spent improperly, it could create a vicious repayment cycle that can be difficult to keep up with.

You have probably heard the word "debt" tossed around more often than not, but what does it mean?

Debt is any money that you owe to someone else. That money could be owed to a bank, a credit card company, or even a friend who lent you some cash.

There are two types of debt: good and bad. Good debt is buying a house, investing in a business, or paying for college. It is classified as good because it helps you build wealth over time. Bad debt, however, is when you owe money on things that don't appreciate in value or build wealth, such as personal loans or credit cards.

If you are wondering how much debt you have, there are three primary numbers to consider: Total Balance, Interest Rate, and Minimum Monthly Payment. These numbers will tell you what shape your debt is in and how quickly it can be paid off. They will also help show whether refinancing your loans or consolidating them into one loan with lower interest rates may or may not be a good idea. 

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The key to debt consolidation is to consolidate with the intent to payoff rather than recreating a debt cycle. Below gives an outline of how these numbers work for each kind of debt.

Recommended Read: Should I Consolidate My Credit Card Debt?

Total Balance

The total balance is the full amount of debt you owe creditors. It is calculated by adding up all credit cards, loans, mortgages, and anything else you may have a balance.

You will see your balance decrease as you make the required monthly payment. This is because a portion of your payment will go toward the principal or the actual balance, and the remaining amount will go toward interest.

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Interest Rate

The annual percentage rate (APR) is the yearly interest rate charged on a credit card. It is the amount of money that the credit card company is charging you to use their money. 

Aside from the annual percentage rate, credit card companies charge different fees depending on the type of transaction needed. Some of the most common fees include:

Balance Transfer - Transferring a balance from one credit card to another, card companies charge a fee between 3%-5% of the balance being transferred.

Cash Advance - Some credit cards offer this option if you need fast cash. But with quick cash comes hefty fees associated with it. Card merchants charge 3%-5% per cash advance in addition to the money being withdrawn.

Annual Fee - Some credit card companies charge between $95-$500 for being a cardholder each year. As a consumer, you can opt out of fee-based credit cards during the application process.

Over The Limit - Most credit cards decline once you have reached your credit limit. Some, however, impose a fee of up to $35 should you spend over the limit.

Returned Payment Fee - The card issuer will charge you a fee of up to $40 if you do not have enough money to make at least the minimum payment when it is due.

The less risk you appear to a credit card company, the better the credit card offer you will receive with an even better interest rate. This is why knowing your credit score when shopping for cards is important. 

Minimum Monthly Payment

When you receive your statement, it will come with three payment options: minimum balance, statement balance, and current balance.

The minimum monthly payment is the least you must pay to keep your account in good standing. The statement balance is the amount due for the billing cycle. The current balance is the total amount of the most recent bill plus any recent charges.

Paying your bills on time is essential as long as it is at least the minimum amount. Credit card companies will report good repayment history, and it will increase your credit score.

Statement Closing Date vs. Payment Due Date

Despite what most people may think, there is a difference between the statement closing date and the payment due date.

To avoid any extra charges and negative items added to your credit report, paying attention to the statement closing date and the payment due date is essential.

The statement closing date is the last date of the billing cycle. Therefore, purchases made after this date will appear on the following statement. The statement closing date is also the date the card issuer calculates interest fees.

The payment due date is the last day you must make a payment before any late fees or penalties are added to your account. This date will be the same each month as long as you have a recurring balance. By law, the payment due date must be at least 21 days after the statement closing date.

Recommended Read: Tips on How To Improve Your Credit Score

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Grace Period

The grace period is when any credit extended may be repaid without incurring a finance charge due to a periodic interest rate.

During this time, no interest is being accrued on purchases made. In addition, most, but not all, credit card companies offer a grace period. Your grace period renews if the entire statement balance is paid by the due date.

When are Payments Reported to Credit Bureaus?

Major credit card companies report payments on the day interest accrues on your account, also known as the statement due date. Card companies don't always disclose their reporting policies, but you can call and ask when they report.

Debt Repayment Strategy

Debt causes stress and anxiety, making management and repayment difficult. However, creating a debt repayment strategy can help ease the pain. There are several repayment methods to choose from when creating a plan, but three of the most common are:

Debt Snowball - this method requires you to pay off debt first, starting with the smallest debt. Then, pay the minimum balance on all other debt and put the extra towards paying off your smallest bill. Small wins matter.

Debt Avalanche - this method is the direct opposite of the debt snowball. Instead of focusing on the smallest debt first, you will focus on the biggest debt. Then, pay the minimum balance on all other debt and put all extra towards your highest debt.

Personal Loan - With increasing credit card rates, it is safer to consider paying off debt with a personal loan. You will have one set interest rate and payment throughout the life of the loan that will never increase.

Recommended Read: Essential Things to Know About Secured Loans

The Money Wrap-Up

Understanding your debt is the first step toward resolving it. Paying off your debt is a satisfying feeling. Next, make plans beyond repayment to keep you from getting into debt again. Debt repayment takes time, patience, and trial and error. It is a learning process; you must go back to the drawing board several times to start over. The key is never to give up. Paying off your debt will be worthwhile in the end.

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