To the average person, a debt is a debt, but in reality, loans vary in their classification, and different kinds of loans and other debts have their own payment plans, tax implications and impacts on your credit scores.
So what are the factors considered in classifying loans and debts? In this article, we attempt an easy but well-researched breakdown of some of the most common types of debt, as well as how they may affect your finances respectively.
We will discuss them under the type of loan, mode of repayment, interest rate, tax implications and ramifications for your credit scores.
Credit Card Debt
A credit card is a card issued by a financial institution, typically a bank, and it enables the cardholder to borrow funds from that institution. Cardholders agree to pay the money back with interest, according to the institution’s terms.
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- Loan Type: Credit card debt is classified as a revolving account. This means the borrower do not have to to pay it off at the end of the loan term/tenor (usually the end of the month). It is also an unsecured loan, which means there are no physical asset like a house or car tied to the loan that the lender can repossess to cover the debt if you don’t pay up.
- Interest rates: Rates vary by card, credit scores and your history with the lender, but they tend to range from 10 to 25 percent, with an average interest rate of around 15 percent.
- Method for Repayment: To remain in good standing, you’re required to make a minimum payment on your credit account each month if you carry a balance. However, paying only the minimum can allow interest charges to build up and make the debt nearly impossible to pay off. Tackle existing credit card debts by paying as much above the minimum as you can, then commit to spending no more each month than you can pay off when your statement comes.
- Tax Implications: There are none, as payments made on credit card debt are not tax-deductible.
- Ramifications for your credit scores: A long history of making payments on time can be good for your credit scores. However, a borrower must be careful about opening too many accounts or getting too close to his/her credit limits.
Mortgages
A mortgage is an agreement between you and a lender that gives the lender the right to take your property if you fail to repay the money you’ve borrowed plus interest. Mortgage loans are used to buy a home or to borrow money against the value of a home you already own.
Type of loan: 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, which typically includes seizing the property and selling it to get back its money.
Interest rates: Depending on the state of the economy, interest rates on home mortgages tend to range between 3 and 5 percent. If you have an adjustable-rate mortgage (ARM), your interest rate may change from year to year within certain parameters.
Method for Repayment: You generally make a payment on your mortgage once a month for the term of the loan. Although some mortgages may require you to pay twice a month, those are pretty rare.
Ramifications for your credit scores: Provided you make your payments on time, a mortgage can often help your scores because it shows you’re a responsible borrower. Having a mortgage helps diversify your credit portfolio, which can also help your scores. Also of note, this type of debt doesn’t count toward the credit utilization rate portion of your credit scores.
Auto Loans
Type of loan: 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 rates: The longer the term of your loan, the lower your interest rate will probably be. Many auto companies offer low- or no-interest financing deals for individuals with good credit.
Method for Repayment: Because this is an installment loan, you pay it off in a set number of monthly payments over several years.
Tax implications: There are none, as payments made on auto loans are not tax-deductible.
Ramifications for your credit scores: Like a mortgage, making on-time payments on your auto loan will help you build a positive borrowing history and also help your credit scores.
Student/Study Loans
Type of loan: Student loans are unsecured installment debts, but the payment terms are more flexible than other loans.
Interest rates: Interest rates on this type of loan often vary by Lender.
Method of Repayment: Student loan payments are commonly calculated for a 10-year payoff period, but there is no rule of thumb to this.
Tax implications: Interest paid on student loans is tax-deductible up to $2,500 provided your gross income is not more $80,000 (or $160,000 if married filing jointly).
Ramifications for your credit scores: Student loans are often some of the first debts borrowers take on, so they can be an important means of building a strong borrowing history. As with other debts, paying your student loans on time each month helps your credit scores.
Medical Debt
Type of loan: Medical debts are not secured by any kind of property and usually don’t come with an assigned payment period or structure. Most hospitals and other health care providers have a billing department, and you can often work with your provider to set up a payment plan if you can’t pay the full amount of your bill right away.
Method of Repayment: This really depends on your doctor or hospital. Ideally, they want you to pay it off all at once, but that might not be possible if you’ve had, say, an extended and costly hospital stay. Again, talk with the provider’s billing department to see if you can work out a payment plan or negotiate a lower price for the services you’ve received.
Tax implications: Qualified medical expenses that exceed 10 percent of your adjusted gross income can be deducted from your federal taxes.
Ramifications for your credit score: As with any debt, if your health care provider turns your account over to a collection agency, your credit score could drop.
Additionally, if the debt does make its way onto your credit reports but is later paid off by your health insurance provider, the debt will be reported as paid. If instead the debt is reported as being in collections, it can remain on your credit reports for
Ramifications for your credit score: As with any debt, if your health care provider turns your account over to a collection agency, your credit score could drop. Additionally, if the debt does make its way onto your credit reports but is later paid off by your health insurance provider, the debt will be reported as paid. If instead the debt is reported as being in collections, it can remain on your credit reports for up to seven years, even after you pay off the debt.
Summary
The type of debt notwithstanding, the most important thing is to keep up with your payments each month. That way, you can clear your debt with ease avoid negatively affects on your credit scores.