Whenever you take out a line of credit, such as a loan or credit card, you create something called debt. Here, we explain everything you need to know about debt.
What is debt?
Debt is created when you borrow money, this could be from a business or person. You have to pay the money back, plus potentially pay interest over an agreed period of time. There are many different types of debt, including:
What is good debt?
Any debt that is well managed and repaid on time could be considered ‘good’ debt. For example, keeping up with your loan or mortgage repayments. Or even staying within your credit card limit and clearing your balance each month. Good debt that is managed correctly may help to improve your credit score.
What is bad debt?
Bad debt, or problem debt, usually arises when you have difficulty making repayments. This may be because you can no longer afford to pay off your debt or that you missed payments due to extenuating circumstances – perhaps you’ve been diagnosed with an illness or mental health condition.
Problem debt tends to escalate quickly and become increasingly expensive as more interest is charged on what you owe. It can negatively affect your finances, for example, making your credit score go down.
Bad debt can also lead to serious consequences if you don’t act quickly, including:
- legal action
- bailiffs or debt collection agencies
- eviction or repossession of your home
- disconnection from your energy supplier
It’s important to get help as soon as possible if you’re having trouble managing your debt. Contacting a free debt charity for independent advice can help you take action to pay off what you owe.
» MORE: How to get out of debt
How much could I borrow?
How much you could borrow depends on the type of financial product you apply for and your financial circumstances.
For example, long-term borrowing, such as mortgages and personal loans, are used for large sums of money. Whereas short-term borrowing options, such as credit cards and overdrafts, are used for smaller amounts.
Your credit score may affect how much you can borrow too. As a general rule of thumb, a higher credit score improves your borrowing power because it suggests that you have a good track record of managing money and repaying. It might also give you access to cheaper interest rates.
In contrast, a low credit score may limit your chances of being approved by a lender because it suggests that you might not be able to repay your debt.
It’s important to note that there isn’t a universal number that counts as a ‘good credit score’ and guarantees you’ll be successful when you apply to borrow money. Lenders also take your wider financial circumstances into consideration too, such as your income, outgoings and employment status.
» MORE: Ways to check your credit score
How to repay debt
How you repay your debt will vary depending on the kind of debt you have and how it is structured. For example, mortgage repayments are paid monthly over a long period of around 25 years.
Some debts, such as personal loans, can only be repaid in instalments and you may be penalised with an early repayment charge for clearing them faster.
In other cases, such as with a credit card or payday loan debt, repaying in full may mean you will be charged less or no interest. Generally, the longer you take to repay the debt, the more interest you will pay.
Make sure you understand the terms of the money you borrow to ensure that you know what the repayment plan looks like.
Am I liable for my partner’s debt?
You are not automatically liable for your partner’s debt if you are married or in a civil partnership. Instead, you’ll only be liable for debt that you have agreed to. For example, when you take out a joint mortgage, both you and your partner will be liable for the repayments.
What happens to my debts when I die?
Your debts won’t automatically be written off when you die. Instead, the person in charge of managing your estate, known as the executor or administrator, will need to use any assets remaining in your estate to pay off your debts until there is no money left. Any outstanding debts are then likely to be written off.
» MORE: Planning your estate: things you need to know
Can you inherit debt?
Debt cannot be inherited in the UK. Instead, it is paid off using money from the deceased person’s estate.
If there isn’t enough money in the estate to cover all of the remaining debt, it becomes known as an ‘insolvent estate’.
This means that some debt such as household bills may be passed on to anyone still living in the deceased person’s home.
If you have joint financial products, such as a mortgage or you acted as a guarantor for someone, you may also be liable for their debt after they die.
What happens if I can’t repay my debts?
If you are struggling to repay your debts or to afford your interest payments, there is help available and you should seek it as soon as possible as the longer you ignore the problem the worse it will get.
Be wary of anyone who charges you money to help consolidate your debts or manage them better. Try debt charities such as StepChange or National Debtline, which offer specialist debt advice free of charge.
» MORE: Debt management plans
Image source: Getty Images
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