Ask any millionaire about attaining wealth and the first thing they will tell you is to get rid of your debt.

As the bible states, “The borrower is slave to the lender.” 

If debt is so bad, why do we have it?

The most common reason is that many people are living a life that they can’t afford. They borrow money from financial institutions to purchase items or assets that they have no security for paying back.

Some people buy fancy cars, big houses and designer clothing to keep up with the Jones’ but cannot afford those items, so they borrow money. 

Wealthy people will always tell you to always pay in cash. Some people will say, “But I don’t have the cash.” That’s a great sign that you can’t afford to buy what you want. Save up the money, then buy it.

Although wealthy people provide great advice about financial prosperity, most average folks don’t listen. Since they’re going to take on debt anyway, we thought that we should provide an explanation about the five different types of unsecured debt.

What Is Unsecured Debt?

Unsecured debt is a loan that a financial institution issues, and it’s supported only by the borrower’s creditworthiness, rather than a type of collateral. 

Unsecured debt, otherwise known as signature loans, get approved without the use of assets as collateral. A financial institution will issue the loan based on the applicant’s credit history. The borrower needs to have a high credit score, which is a numerical representation of a borrower’s ability to pay the debt.

In the case of secured debt, the lending institution will have an asset from the borrower as leverage that they can claim to settle the outstanding amount if the borrower defaults on the repayment.

How do the different types of debt vary?

A revolving loan has a credit limit that can be spent, repaid and spent again. With a term loan, the borrower repays it in equal installments over the agreed term.  

Credit Cards

This is one of the most common forms of unsecured debt. Most people who can have a credit card have taken the opportunity. 

We use our credit cards to buy plane tickets, clothing and even food. Some of us tend to get carried away by maxing it out and not repaying at the end of the month. Studies have shown that the reason people spend more with credit cards than cash is that they don’t see the physical money leaving their hands, unlike cash. 

When people spend cash, studies have shown that their feelings get hurt because they’re parting ways with money. That doesn’t happen with credit cards.

How bad is credit card debt?

Pretty bad. 

What makes credit cars so appealing is that it’s a revolving line of credit, allowing an individual to borrow each month and carry balances over.

Interest rates on credit cards are high. The average is 15.3 percent, but it can increase to 25-29 percent if an individual carries over the payments to the following month. Sadly, many people succumb to the habit--some even habitually. 

If you’re going to use your credit card, make sure that you settle the balance at the end of the month so that you incur minimum interest charges. Credit cards are like a vicious cycle - once you get yourself into the debt and carry it over to the following months, you get stuck with the debt for a long time. 

Sometimes for life.

Personal Loans

Otherwise known as signature loans, personal loans have become a popular option amongst many borrowers. 

Borrowers can use personal loans for various ventures like funding a start-up business or paying for the renovations on your home. Some people even use the money to go on vacation. When you’re borrowing money to go on vacation, that’s a good sign that you don’t have money and shouldn’t be going on vacation.

Most personal loans have a cap and are funded by a bank, an online lending source, or a credit union. 

In most cases, the lending terms depend on the borrower’s credit history. The better their score, the more beneficial the terms and lower the interest will be. 

One thing that appeals to borrowers about personal loans is that they have a lower interest rate than credit cards. 

Long gone are the days where financial institutions used to be extremely strict about issuing a personal loan. It seems that these days they are willing to give it out to anybody who promises to pay it back. 

Although financial institutions run background checks to assess the risk of giving out a personal loan, they have made loan options available for people with bad credit or for people without a financial track record.

Business Loans

An unsecured loan that financial institutions take a big risk on issuing is a business loan. Considering that most businesses fail within the first six months of establishment, banks are taking a major gamble on issuing out these loans.

Some entrepreneurs don’t use business loans to start their business but rather as a credit line that can be the business’ lifeline.

Here’s how it works:

Credit lines consist of traditional and non-traditional lines.

Traditional lines provide a fixed amount of money and come with check-writing privileges. The problem with these lines is that the bank can discontinue it anytime, especially in an economic downturn. When that happens, entrepreneurs have a short period before they have to repay the loan. That can put more financial pressure on them.

A good example of a non-traditional line is a company credit card. The bank offers a limit on borrowing, but the perk is that the bank is less likely to withdraw this credit line.

Student Loans

This is one of the biggest debt problems in America. Hundreds of thousands of students graduate each year from universities and carry a mountain of debt with them before they’ve landed a job.

Why are student loans so appealing?

Like most unsecured debt, student loan terms depend on the credit history of the borrower. What makes these loans so appealing is that they provide students the time and resources to concentrate on their studies, as the payments are deferred after graduation.

The government doesn’t back private student loans, and the applicant doesn’t have to fill out the Free Application for Federal Student Aid but will have to prove that they’re capable of repaying the loan. 

Students who apply for these loans and don’t have a credit history will need a cosigner, making them liable for the debt if the applicant is incapable of repaying it.

Peer to Peer Loans

This type of loan is like an IOU. These loans happen between individuals. One person borrows money from another person. Talk about risky.

Peer to Peer Loans are like signature loans - the lender stipulates the terms of the loan such as the fixed-rate installment and the period that the borrower has to pay back the loan, as well as the interest rate.

These loans usually happen between family members or close friends. There are websites that allow borrowers to post requests for such loans. 

The problem with these types of loans is that when you borrow money from family or friends and can’t repay, not only do you owe the debt, but you also risk losing the relationship with that person.

The benefit of borrowing from your family or friends is that they tend to be more understanding when you need an extension on the repayments, so negotiations are easier with them than a financial institution.

The other perk is that your family member or friend is more likely to give you better terms than a bank or credit union.

Whatever you can do to avoid debt, do it. Debt is the number one reason that most people never prosper financially. Remember that the good rule of thumb to follow is to pay everything with cash and if you can’t, then that means you can’t afford what you want.

Debt is keeping you away from wealth but at the very least, financial independence.