Debt is often thought of as a negative thing, but when it is appropriately managed, borrowing can help pave the way to greater wealth and ultimately, financial freedom.
However, not all debts are equal. The word ”debt” covers every borrowing imaginable: from mortgages to a tenner borrowed from a mate at the pub.
This article covers some of the main categories of debt and breaks down the most common forms of debt among UK consumers.
Secured v Unsecured Debts
All types of debt can be broken down into two categories: secured debt and unsecured debt.
Secured debt is borrowing taken out against the value of an asset or your belongings. If you don’t repay your debt, the lender can ”repossess” your asset and sell it to recover their money. In modern times, the most common assets used for security are properties and vehicles.
Because there is collateral in place in case things go awry, lenders are often happy to charge lower interest rates on secured debts, because they are not viewed as risky investments.
Examples of Secured Debts Include:
- Mortgage – Uses home as security
- Logbook loan – Uses vehicle as security
- Pawnbrokers – Uses personal belongings for security
- Equity release – Uses the home and estate of the borrower as security
Unsecured debt is a debt which is borrowed without being secured against any property. If the borrower fails to pay back their loan, there is very little the lender can do to recover their losses. For this reason, unsecured lending is considered comparatively risky, and so lenders tend to charge higher interest rates.
Credit scores are relied upon to establish trust. A credit score is a ”rank” given to consumers by ”credit reporting agencies‘ based on their past financial behaviour. It helps lenders to estimate the risk involved in lending to a particular consumer.
Borrowers with low credit scores are considered risky investments, so lenders charge them high-interest rates to help offset the risk. However, if you have a high credit score, lenders charge lower interest rates.
Even though lenders cannot repossess property or possessions if someone defaults on an unsecured loan, there are still actions which can be taken that can cause serious problems for the borrower.
If you don’t keep up with the repayments on an unsecured loan, the lender reports this to credit reporting agencies.
The agencies will record this on your credit file and lower your credit score, making it hard for you to borrow in future.
For certain debts, lenders may also file legal action against borrowers who don’t pay them back.
Examples of Unsecured Debts Include:
- Personal loans
- Credit cards
- Store cards
- Council tax
- Payday loans
Certain kinds of unsecured debt fall into a category known as ”revolving credit”. This is a debt which has no fixed term and can be used the borrower as and when they please up to an agreed limit.
There are fees and interest charged whenever the borrower dips into their revolving credit, but they have the flexibility to pay it back whenever they please.
Lenders and credit reporting agencies may take large amounts of revolving credit as a sign that someone can’t afford to repay their debts or is struggling to manage their expenses.
People in this situation are taken to be high-risk borrowers and could e refused credit or met with high-interest rates when they apply.
Examples of Revolving Credit Include:
When it comes to managing your debt, it can be helpful to split them into priority debts and non-priority debts. Priority debts are debts which, if left unpaid, could quickly result in serious consequences for the borrower. Secured debts are almost always considered priority debts.
Priority Debts Include:
- Mortgage and rent
- Energy bills
- Logbook loans or hire purchase arrangements on essential vehicles
- Any payments due to the council, the courts, HMRC or DWP (e.g. council tax, court fines or income tax)
- Child Maintenance
Non-priority debts still need to be paid, but lenders may be more flexible and the immediate consequences of non-payment less severe than with priority debts.
Non-Priority Debts Normally Include:
- Credit card debt
- Overdraft debt
- Store card debt
- Water bills
Most Common Kinds of Debt in the UK
According to the Bank of England, the average adult in the UK currently owes £30,575, excluding mortgages and student loans.
Debt charity StepChange says that 17% of UK borrowers took out a loan to help them through a job loss, while 11% blamed overspending for their debts.
There are millions of people in the UK in debt, but what kind of debt is the most common?
Most Common Form of Personal Debt in the UK
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How Can Love Debt Free Help?
Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.
They have already helped thousands of people reduce and manage their debts, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these debt help companies, click on the below and answer the questions.