Essentials of Debt

When you borrow money, you are responsible for paying not only the amount borrowed, but also fees and interest. In order to estimate how much you will pay in total for borrowing money, you should consider the following costs.

If you are working with a lender, they should be able to answer questions about when and how you’ll pay for these costs, especially if it’s for a large loan for a car or a house. Your lender works for you—you are paying them! Ask them questions. Chances are they’ll want to provide you with all the information they can to make it more likely you'll borrow from them.

Fees

Fees are miscellaneous charges from the lender that can be levied against your account. These fees could be added to the balance of your loan or credit card bill, deducted from the disbursed loan funds, or requested up-front, before you can access your funds. 

Here are some common examples of fees:

  • Origination fees: the cost of processing your loan

  • Early payment fees: for paying off a loan early

  • Annual fees: for having a specific credit card each year

  • Cash advance fees: for using your credit card to take cash from an ATM

  • Balance transfer fees: for transferring a balance from one card to another

  • Late payment fees: for paying your bill late

  • Over-the-limit fees: for spending over your credit limit

Down payments and closing costs for a house or car are also types of fees. 

Interest

In addition to fees, interest accrues on your owed balance. Interest can be simple or can compound. To understand simple and compound interest, watch the video below.

Compound Interest Concept Video from Council for Economic Education on Vimeo.

Debt Types

Debt exists in two common forms:

Revolving Debt

With revolving debt, you can borrow up to a credit limit, and continue borrowing up to that limit monthly so long as you pay the balance you owe.

Credit cards are an example of revolving debt. Credit cards allow you to access a line of credit to make purchases, then pay the balance accrued at the end of the billing cycle. This is different from a debit card because instead of deducting purchases from your bank account automatically in real time, the card issuer pays for your purchases and you repay the issuer. 

Installment Debt

With installment debt, you borrow one lump sum and pay it back in regular amounts and time intervals. 

Loans are an example of installment debt. This includes student loans, mortgages, auto loans, and more. 

Key Terms

Here are some key terms and concepts you should understand before you decide to borrow. 

Annual Percentage Rate (APR)
Interest Rate
Lender
Master Promissory Note (MPN)
Grace Period
Principal
Term