Debt 101: a basic introduction to debt
This article is part of a new series on debt and loans.
Finance can make the best of us apprehensive, and the majority steers clear of anything beyond the basic knowledge. Some people don’t even use the bank for anything beyond safekeeping their money, but what about its other uses? It can seem as though a heavy rock band is residing in your head at the thought of all the intricate financial scopes you’re not keen on familiarising yourself with.
However, there are things that are imperative to know before you decide to undertake any financial transaction, particularly ones that involve debt like a loan or credit card. And before you tell yourself, “But I’m not even planning on taking out a loan or using a credit card,” debts aren’t restricted to these sole transactions.
Keeping it simple, we’re here to help you avoid troubles and tell you everything you need to know before incurring any debt.
Debt explained
In case you didn’t know, debt is any type of money you borrow whether from another individual or an institution such as a bank. The most common types of borrowing money are loans and credit cards. It’s typically used to finance a certain purchase, like a home, car or any other personal expenses you wouldn’t be able to afford under different circumstances.
When returning the money you owe, you won’t pay it all at once, especially if you’re taking out a loan. Instead, the bulk payment will be divided into monthly instalments to ease the financial burden. On top of these instalments, you will also be asked to pay a little more cash also known as interest. Credit cards, however, work in the same way, where you borrow an amount by paying with a card and you pay back the full amount at the end of a monthly cycle.
Common forms of debt
Loans can be housing loans, personal loans, or auto loans. Before you take out a loan, there will be specific terms — financial charges, interest rate, and a repayment date — you must negotiate and agree to with the bank. Some loans that are large in sum will require the borrower to put down a collateral, which is a certain asset a lender requires as a security for a loan. For example, if you’re taking out a housing loan, you can put down the house or any other assets you might own as collateral.
Credit cards are physical cards issued by a bank or financial institution. They come in handy when you don’t have money at the moment to purchase a certain good or service. These cards either have a predetermined limit, usually quadruple your salary, and what makes them tempting is the possibility to earn rewards every time you use them. Like any other form of debt, a cardholder is expected to pay back the money either over time or by an agreed upon billing date along with interest payments and stated financial charges.
Debt terms to familiarise yourself with
Interest rate: You’re going to hear this one a lot! It’s the amount a lender charges a borrower and is expressed as an annual percentage of the principal amount — the amount you borrowed. Assume it’s now time to pay your monthly instalment and you borrowed 3,500 JOD from the bank. If the contract involves a 5% interest, then you’ll be paying 3,675 JOD — the 3,500 JOD you owe along with the interest 3,500 x 0.05= 175 JOD.
Defaulting: This term refers to when the borrower fails to pay back their due amount on time. Depending on the contract between the bank or borrower, a debt default may take place after you miss one payment or several consecutive ones. To avoid unnecessary headaches and drama, make sure to pay back the money in full and on time to mitigate the risk of defaulting.
Debt to Burden Ratio (DBR): This is a ratio typically used by banks to calculate your eligibility when applying for a loan. Each bank has a certain set of regulations and eligibility criteria, although a general rule of thumb is that your DBR has to be below 50% to qualify for a loan. It is calculated by dividing your total debt over your total assets. So, assume you earn 2,000 JOD a month, and 500 JOD goes towards your debts. 500/2000= 25%, which means, you’re qualified for a loan.
So, now that you’ve got a few insights about debt, you’re going to be much more prepared if you ever decide to take out a loan or get a credit card or undertake any transaction that involves you borrowing money. Remember to be responsible with your finances and stick to the rules and regulations to avoid unnecessary trouble.
