30 Types of Debt

Many Canadians have some type of debt that is a constant stressor in their lives.  As many Canadians seek home ownership, mortgages are usually one of the largest debts for households.  Before starting to formulate a plan to live debt-free as a trade worker, it’s important to understand the various common types of debt and how expensive it can be to borrow funds.

Secured Debt vs. Unsecured Debt

Secured debt refers to any debt that is backed by some form of collateral.  One of the most common forms of secured debt would be automobile financing.  The physical vehicle acts as the collateral to the auto loan.  If the borrower were to default on payments, then the vehicle can be seized and forfeited.

Unsecured debt refers to loans that lenders do not require to be backed by collateral or an asset.  It is critical for lenders to assess an individual’s credit history and financial situation in approval of this type, as there is no asset used as collateral in case the borrower is not able to make payments.  Credit cards and student loans are common examples of unsecured debt.  If one does not have sufficient funds to pay the credit card balance in a timely manner, then individuals will face penalties and interest charges from the credit card companies.  There is no asset acting as collateral that an individual can relinquish to the credit card companies.

Good Debt vs. Bad Debt

Resources tend to classify and discuss debt as being ‘good’ or ‘bad’.  Generally, debt that drains an individual’s financial situation is considered ‘bad’.  Examples of ‘bad’ debts include credit card or auto loans, which have high fees to borrow or the asset depreciates in value over time.  ‘Good’ debt is considered loans with very low interest rates or debts that one can leverage to increase their future income and net asset basis.  Student loans tend to have zero interest over the duration of the education period, and will allow trade apprentices to complete qualification to earn higher income amounts as an apprentice progresses in the trade certification process.  A small business loan allows one to secure capital to assist in growing a business that will have higher value in the future.

Overall, taking on any debt that is beyond your financial means or will not increase your net worth is not recommended.  Even loans that may be considered ‘good’, can lose its value if there’s a crash in the market or there is no work available in the economy when one graduates with student loan debt.  Living debt-free allows one to focus more on saving for the future, building upon an asset base, and taking advantage of compounding returns.  Trade apprentices have a significant advantage in the pathway towards trade qualification, as one gets to earn as they learn.  This increases the chances that one is not in significant debt when completing any trades program.

Personal Lines of Credit

• Personal lines of credits allow borrowers to have a revolving credit amount with a financial institution. Individuals can borrow funds up to a pre-determined amount, and utilize the funds however they want.  Usually the interest rates on personal lines of credits are very high, as they have great flexibility.

Credit Cards

Credit cards allow individuals to purchase items up to a pre-set limit.  A monthly statement is provided in which the borrower must meet a minimum payment amount.  If the monthly purchases are not repaid in full within the monthly statement date, then a fixed interest rate is applied to the remaining balance owing usually compounded on a daily basis.  Credit cards usually have a high annual percentage rate.  With daily compounding of interest, fees accrue very quickly the interest on interest amount.

Payday Loans

Payday loans are typically very short-term loans with very high fees.  It is called a payday loan as a borrower needs to pay back the loan with the next paycheck.  The fees on payday loans are extremely high, such that each provincial or territorial government limits the fees charged on a pay day loan.  Payday loans are different than traditional loans in that it is for a short period of time (only few weeks), one can usually qualify without a credit check, the borrower pays a flat fee instead of interest if were to pay on time full amount, and the lender organizes the pay back based on payroll schedule.  Overall, pay day loans are a very costly method of borrowing and should only be utilized when all other measures are exhausted for a very short-time frame.