Debt

When borrowers could not pay their debts, they often fled their homes. That became so common that kings sometimes offered general amnesty for debtors, giving land back to those borrowers who couldn’t pay.

In 1694, the British government formed the BoE to raise capital for its war with France.

For many years, consumer debt was nothing to write about. But once the first universal credit card (Diners’ Club) was introduced in 1950, consumer debt began to take on a different character. The first credit cards were actually charge cards, where any balance due had to be paid back immediately; you couldn’t run a balance.

Loan agreements don’t have to be written, but it’s better when they are. That’s especially true of loans made between friends (who want to stay friendly) or family members. Written agreements can prevent arguments down the line (such as disputes over how much was borrowed in the first place). They can serve as proof that the money was loaned rather than gifted. If there’s interest involved, the agreement can include how the interest is calculated and what portion of each payment goes toward interest. Bottom line: Whenever you borrow or lend money, put something in writing to protect both sides.

Annual percentage rate (APR): the total charges you would pay (the cost of your loan) if you borrowed the full loan balance for an entire year, converted to a percentage and often used for comparative purposes.

APR and interest rates may look the same, but they’re not. APR includes the total borrowing costs — interest and fees — that you’d pay over 1 year on the original loan amount, converted to an annual percentage. Interest rate includes just the percentage you’ll pay periodically based on the outstanding loan balance.

Amortize, based in Latin, technically means “to kill.” In loan lingo, it refers to “killing off” a loan by paying it down. Amortization is used for installment loans, where you make a specified payment (rather than choosing your payment like you can with credit cards, for example) every month. Over time, a portion of each payment reduces the principal balance of the loan, right on schedule.

Amortization is an accounting process that gradually reduces a loan over time with installment payments. Each installment payment is split into principal and interest portions. While the total payments stay the same, the interest and principal portions change every time.

From a borrower’s perspective, paying secured debts takes top priority when there’s not enough money to pay every bill. Though these payments often take up more of the available budget, you stand to lose crucial assets (like your home or your car) if these debts are not paid regularly.

Unsecured debt doesn’t come with the security of collateral. Here, the lender is banking on your ability and willingness to make all of the scheduled payments.

Examples of unsecured debt include:

Student loans.
Credit card debt.
Personal loans.
Medical bills.

Revolving and nonrevolving describe the way money is borrowed. Revolving debt allows you to borrow money at will, up to a preset limit, and then borrow that money again as often as you like. Nonrevolving debt refers to a one-time loan for a fixed dollar amount, and once it’s repaid, you can only borrow again by applying for a new loan.

Revolving debt makes up about 25% of the total outstanding US consumer debt. That’s because individual nonrevolving loans tend to be bigger, covering big-ticket items like mortgages, student loans, and car loans.

Predatory lenders take advantage of desperate or uninformed borrowers. While these lenders often pretend that they’re helping you, their only goal is maximizing their profits by lending you as much money as possible at the highest interest rate possible. They don’t care if the debt is too much for you to manage based on your current financial situation. In fact, they often specifically target people who can’t really afford the loans. Those borrowers often end up trapped in a dangerous debt cycle with thoroughly trashed credit. Many end up losing their homes.

Blank spaces. If a lender expects you to sign a loan contract with any (even one) blank spaces in it, do not sign it. I can’t stress this enough: Never sign a contract with blank spaces.

Vague answers. Reputable lenders help make sure you understand everything in the loan documents and will clearly answer all of your questions. Predatory lenders won’t give you straight answers and may “reassure” you that they’re taking care of everything so you don’t have to worry. If your questions get vague (or no) answers, don’t sign.

Predatory lenders know you’re in a tight spot; that’s why they’re talking to you. They’re hoping that you’re so desperate for money you’ll just sign anything they put in front of you. They promise an “easy way out” of your financial hardship, but that promise is a lie. With predatory lending practices, your financial situation will only get worse.

The best time to borrow money is when you don’t need to do it, but choose to do it. When you’re financially stable with great credit and a high net worth (especially if you have a lot of liquid assets, which can be quickly converted to cash), lenders will trip over themselves to offer you loans. That means you’ll be in the strongest possible position to negotiate terms that benefit you, mainly very low interest rates.

When it comes to debt, the type makes a big difference. Good debt goes toward building your net worth by investing in assets (including yourself); the goal of this debt is to increase your fortune or your fortune-growing ability. Bad debt eats away at your net worth and jeopardizes your current and future financial health. This type of debt is used to buy things that won’t add value to your nest egg or boost your income. Some debt falls into the middle (like car loans) and doesn’t fit neatly into either the good or bad category.

Borrowing money to pay for discretionary expenses (things you want but don’t really need) counts as bad debt.

Using credit cards and having credit card debt are not the same thing. Credit card debt involves a balance due that can’t be cleared with a single payment. This tops the list of bad debt for 3 important reasons:

High interest rates.
Payment schedules designed to keep you in debt.
Often used to buy consumables, services, and goods that immediately lose value.

Payday loans fall into the toxic debt category, as they come with frighteningly high interest rates — some as high as 500% a year — and are virtually impossible to pay back.

Investing in yourself.

Education is an asset. A business you’ve built is an asset.

Expenses have no lasting value; they’re consumable items that range from food to electricity to pencils. Borrowing money to pay for expenses is one of the fastest paths to financial insecurity. In fact, the number one rule of wealth building is to never spend more money than you earn.

On top of that, loans made to cover expenses are generally unsecured (like personal loans), revolving debts (like home equity lines of credit), or both (like credit cards). These types of loans come with the highest interest rates, even for people with good credit.

When you can earn money using other people’s money (OPM), you’re on the fastest path to building wealth. The trick here is to use their money to increase your net worth. That starts with qualifying for the best possible terms, like ultra-low interest rates, and buying assets that will increase in value, supply cash flow, or both.

There are times when money is so tight that it’s impossible to make student loan payments. Don’t just stop making payments. Your loan will turn delinquent, then go into default, and that can have lifelong financial consequences that are difficult (but not impossible) to recover from. If your finances have taken a turn for the worse, get ahead of the problem by contacting your loan servicer to see if you’re eligible for loan deferment or forbearance.

Both of these allow you to hit pause on your loan payments or reduce your payments to a manageable amount.

Credit card companies increase convenience at every turn. Their goal: getting you to use your credit card for everything and make the smallest possible monthly payments. They encourage you to overspend by dangling rewards in front of you.

Minimum payments on credit cards are specifically calculated to keep you in debt for as long as possible.

Being in debt often triggers feelings of anger, guilt, blame, and shame. You may feel hopeless if your debt seems overwhelming, like you’ll never be able to get a handle on it. Those negative emotions make it harder to face your debt and may keep you from taking steps to get rid of it.

Remember, lenders may seem to care about what’s best for your budget, but they really care about selling you a loan so they can make money. It doesn’t seem like that when you’re trying to get approval; it feels like you’re trying to convince them to finance your house. Remember this: The bank is not on your side, and the bank always wins.

When home prices drop, homeowners can end up upside down on their mortgage, meaning they owe more money on their mortgages than their homes are worth. Technically, that’s known as having negative equity, and it happened to many homeowners during the 2008 housing crisis.

Normally, ARM loans start with an introductory fixed-rate period, and the rate starts to adjust after the fixed period is up. Those introductory rates are often much lower than fixed rates to entice homebuyers, allowing people with less secure finances to buy houses more easily.

30-year mortgages are the gold standard in the lending world, mainly because of the more affordable monthly payments than loans with shorter terms. Lower payments mean there’s more money in your budget available to go toward savings (retirement, emergency funds, college) — but that’s only a benefit if you funnel the difference (or at least part of it) into savings.

For one thing, banks love shorter loans (they’re lower risk) and reward these borrowers withe lower interest rates, sometimes as much as a full percentage point lower than their 30-year counterparts. That combined with the much shorter time period means huge savings on interest costs.

Mortgage lenders often make prospective homebuyers feel like they’re auditioning, like borrowers have to sell themselves to lenders to get approval. That’s backward. You’re the customer here, and you deserve the best possible mortgage product for your situation.

Lenders will try to sell you the loan that’s best for them. Your job is to ignore them and get the loan that’s best for you.

You loan will (probably) be sold.

The mortgage lender you start out with may not be the one you end up with. Most mortgage loans are sold to loan servicing companies. When this happens, the only thing that will change for you is where you send the payments; it won’t affect any of the loan terms.

When you’re facing an urgent financial crisis, a payday loan may feel like a gift, but it comes with very expensive strings. Payday loans come with exorbitant interest rates that can make them nearly impossible to pay off. If you have any other option, use it instead.

Medical bills are the leading cause of bankruptcy.

Before you pay any medical bill, no matter what size, look at it carefully. Medical billing mistakes are freakishly common.

Medical service providers have a lot of flexibility when it comes to setting prices, but those prices aren’t etched in stone. Those providers can be purposely vague in their billing practices, hoping that patients will just suck up and pay whatever they charge, but that also gives them a lot of wiggle room in negotiations. If a bill doesn’t make sense, call the phone number on the bill (it won’t be your doctor) and ask them to reduce the charges.

When you can’t pay a bill all at once, practically all providers offer payment plans. You have to call them to get this set up, and it’s best to do it right away before a collection agency gets involved.

The 3 most common reasons for business loans include:

Starting a business (start-up loans)
Covering regular expenses (working capital)
Expanding your business (including equipment purchases)

To get a business loan, you need to demonstrate the ability to pay it back. That means paperwork, and usually a lot of it. Commonly requested documents include:

Business plan.
Personal and business bank statements.
Personal and business income tax returns.
Personal statement of net worth.
Business financial statements.
Business legal documents.

Your highest priorities on this list include debts that would change your life in a negative way if you didn’t pay them. Mortgages and home equity loans usually tank number one here, because if you don’t pay those you can lose your house. Car loans typically come in second.

When you get a call or a letter from a debt collector, your instincts will probably tell you to either respond or ignore it. Both of those options are mistakes and can come back around to hurt you. If you communicate at all with the collector about the debt or if you pay any amount toward the debt, you have officially acknowledged the debt. If you ignore every communication, which may include court summons, you could end up with a judgment against you that allows the collector to garnish your wages.

The right way to handle collections is to start by requesting a validation letter, which they must provide within 5 business days of the first contact. That letter must include full details on the debt, complete contact information for the collections company, and an explanation of how you can challenge the debt.

Collectors may have incorrect information. Collectors also may lie. Demand proof of the debt they’re trying to collect, and make sure it is both legitimately yours and correct. Once you’ve asked them to verify the debt, they have to leave you alone until they provide the information you requested. If they don’t send you proof of the debt, you can demand that they stop contacting you with a cease and desist letter.

Any time you communicate with the debt collector, keep a full record. Keep copies of everything you send to them, and only send written communications through certified mail (so you have proof they received it). When you speak with them, either record the call (with they knowledge) or take detailed notes during the conversation. Document the date and time of the call, the collector’s name, and everything you discuss.

Be very careful what you say to them. They will use anything you say to help them collect. Don’t talk with them about your paycheck, your budget, or other bills you have to pay.

Debt collectors may act forcefully and try to intimidate you, but there’s a legal limit on what they’re actually allowed to do. Among other things, debt collectors are not allowed to:

Curse at you.
Threaten you with violence or arrest.
Harass or bully you.
Lie to you about who they are or what you owe.
Call you before 8am or after 9pm.
Call you at work if you tell them your employer doesn’t allow this type of call.
Call you at specific time if you’ve told them that time is inconvenient.
Call you at all if you ask them in writing to stop calling.

Collectors can and do contact other people in your life, but they’re only allowed to contact them one time and for specific reasons. They are allowed to contact friends, family, and employers for your contact information if the collector is unable to locate you. They can also call your employer to verify employment. However, they are not allowed to reveal that they are debt collectors or the reason they’re trying to contact you.

Collections come with a deadline known as the statute of limitations. The debt is only legally enforceable during that time period; once the deadline passes, it becomes practically impossible for the collector to win a judgment against you in court. Collectors know they’re on the clock, which is one reason they pursue debts so aggressively. The clock starts with the last activity on the debt in question and stops based on a combination of state law and type of debt. If you make a payment (any size) or admit to owing the debt, though, you might restart the statute of limitations.

Many people think of bankruptcy as a financial do-over, where all of their debts get wiped out and they have a fresh, clean credit slate. That’s not true. Here are 7 things you need to know:

If you file under chapter 7, you can lose your house.
Some debts are nondischargeable, including taxes, child support and alimony, student loans, and court fines or penalties.
Bankruptcy filings are public, which means anyone can look up that information.
Creditors can (and usually do) turn to your cosigners for debts that get discharged under your bankruptcy; the discharge is specific to you, not the debt.
You normally need permission to spend any of your own money once you file chapter 13 bankruptcy.
Bankruptcy may not stop creditors from repossessing property used as collateral to secure a debt.
Your credit score will decrease dramatically once you file for bankruptcy, and the bankruptcy can stay on your credit report for up to 10 years.

A chapter 13 bankruptcy works more like a financial fix up that includes a 3-to-5-year repayment plan. Unlike chapter 7, most debts don’t get canceled under chapter 13, but that can be beneficial for someone who might lose their car or other assets under chapter 7.

Mindful spending is not about depriving yourself; it’s about consciously deciding which purchases are important to you and buying only those things. If you grabbing a $8 mocha latte every morning is one of the best parts of your day, that’s $8 worth spending as long as you can afford it.

You know what’s important to you and what brings joy or purpose to your day. Money you’re spending for things that don’t add value to your life are not worthwhile.

If your employer offers a retirement savings plan, like 401(k) or 403(b) plan, and offers matching contributions, get them. If you don’t take advantage of this, you are actually walking away from free money.

An excellent credit score unlocks many financial advantages. That comes with a catch: In order to have a great credit score, you have to use credit. When you use no credit at all, your credit score will decline.

Don’t spend more to score rewards.

Real estate investment loans come with higher rates than other mortgages, even though both have secured assets in play. Borrowing money for a rental property that you will not live in costs more than borrowing money for your primary home, both in interest and loan fees.

You may be tempted to use leverage to rapidly increase your investment holdings, but that strategy — known as margin investing — comes with an enormous helping of risk. You’re essentially gambling, and the odds won’t be in your favor.

With a 40% maintenance margin, your equity would have to stay above $4k (0.4 * $10k). If the value of the stocks in the account fell to $8k, your equity would fall to $3k ($8k - 5k), below the maintenance margin. When that happens, your broker may issue a margin call, which means you have to immediately bring your equity up by $1k by adding either cash or securities to the account. If you don’t do that, the broker will sell your investment and collect their money.

When you invest in debt, you’re either directly or indirectly lending money, just as if you were a bank. The goal is to earn steady fixed income for a long period of time, but there’s no guarantee you’ll enjoy that outcome.

Institutional lenders work with safety nets to minimize their risk of loss whenever they make loans. The 2 main safety nets used are collateral and cosigners, and both protect the lender if the primary borrower does not pay back their loan.

Whenever you lend money, there’s a chance you won’t be paid back; that’s called default risk, and most lenders are well aware of it. There’s another risk that novice lenders may not think about: interest rate risk. You’ll also have to contend with liquidity risk, which speaks to a more limited ability to quickly convert investments into cash.

Bonds come with their own vocabulary that sets them apart from other loans:

Face value: the amount of money (stated on the face of the bond) that will be paid back on the bond’s maturity date and used to calculate the coupon payment.
Issue price: the amount of money the issuer sells the bond for, which usually does not equal its face value.
Coupon rate: the percentage of interest the bond issuer will pay on the bond’s face value.
Coupon payment: the amount of interest in dollars that the bondholder will receive on each coupon date.
Coupon date: the dates on which the issuer will make scheduled interest payments, usually semiannually.
Maturity date: the date the bond comes due and the full face value will be paid to the bondholder.

These basic terms just scratch the surface of bond language.

In the 18th and 19th centuries, debtors in Britain were often imprisoned in jails until their debt was paid (usually by a friend or relative) or they died.