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What is debt and how does it work?


What is debt
What is debt and how does debt work?

Unless you have an abundance of cash at your disposal, at some point in your life you will need to take on debt to acquire items that are unaffordable under normal circumstances. These items may include buying a home or car or raising capital for your business. Borrowing money is necessary so it is important to understand debt, how it works and all the complexities that go along with it. Having this knowledge can inform your decision as to what types of debt are available and more specifically determine whether debt is best for your situation.


What is Debt?

Debt is a monetary obligation owed by one party to another. It is used to finance purchases that a borrower may not be able to afford on their own. A debt agreement is a legal arrangement that allows a borrower to obtain a specific sum of money from a lender under the condition that the amount borrowed will be repaid at a specified time in the future and at a particular interest cost.


What are the types of Debt?

Debt can be classified into two main categories which are personal and corporate. A personal debt refers to a monetary obligation owed by an individual such as student loans, mortgages, and credit cards. A corporate debt is a monetary obligation owed by a company or business such as a corporate bond or a commercial loan.


How does Debt work?

Under the terms of the debt agreement, the lender will provide the borrower with a specific sum of money. The borrower is then required to repay the outstanding balance of the debt by a definite date. This date is usually several months or years in the future. The terms of the debt agreement also make provisions for an annual interest amount to be borne by the borrower.


What is the cost of Debt?

Interest is charged on the debt to compensate the lender for facilitating the agreement and taking on the risk of lending. This interest is the cost paid for borrowing the debt and is expressed as a percentage of the debt. This is also known as the interest rate charged over the tenure of the debt. The debt becomes null and void upon the repayment of the total amount outstanding to the borrower. This outstanding amount includes the initial sum of money borrowed along with any interest being charged.


Final Word

Debt is a monetary obligation owed by an individual or business to another party. It is a legal agreement that the lender will provide the borrower with a sum of money under specified conditions. The borrower is compensated for the risk of lending in the form of the interest charged on the original debt amount.


Thinking of taking on debt? Carefully read the terms of the proposed agreement provided by the lender to determine whether this debt will be right for you. Also get a head start by using the debt repayment calculator to find out if you can afford the monthly repayment.

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