Debt is a sum of money that is due or owed to the creditor by the borrower. Most individuals and businesses use debt to finance large purchases such as buying a car or acquiring business properties. In a debt arrangement, the lender allows the debtor to borrow money under the condition that it will be paid later (Chen, 2021). Usually, the principal amount borrowed is paid with interest. The interest ensures that the lender is compensated for taking the risk to lend money. It also encourages the borrower to repay the debt quickly to reduce the total interest expenses.
I currently have a car loan of $25,000, which I have been servicing for the last year. I used the amount to purchase a minivan that I use to supply groceries to local restaurants. The loan repayment period is 60 months at an interest rate of 5.27% and payments of $475 a month. The loan length was the primary consideration when calculating the amount of interest and the monthly payment that I would be making. In the past year, I have paid $5,700, which means I still owe $22,800 on my minivan. When I pay off the loan in June 2025, I will have paid about $3,500 in interest to Honda Company. The total amount, including the interest that I will have paid to the Auto Loan Company, is an estimated $28,500. When I applied for the loan, I only had one asset to secure the debt. I used a boat that I acquired five years ago whose value the lender estimated at $80,000 as collateral. The boat was enough to cover the amount of the debt. The risk I undertake by being in debt is that in case I am unable to pay off the loan, Honda Company has the right to seize the boat and sell it to cover the remaining amount of the loan. Regardless of the amount remaining, if I default, I risk losing the boat.
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Debt can help build wealth in various ways for individuals. For instance, the car loan I took allowed me to acquire a minivan that has significantly enhanced my business operations. I use the van to supply groceries to local restaurants. The ease of movement and access to farms from neighboring counties has significantly increased the business profits. I can also use the debt money to start new ventures and invest in real estate, all of which would allow the accumulation of wealth in the long run. Another way debt would enable wealth accumulation is by financing education that would build wealth over a lifetime. However, it is important to speak to a financial advisor before taking a loan to finance a new business or invest in a new project to determine its risks.
Financial institutions use the five C's to evaluate a borrower's ability to repay a debt. The five C's are character (credit history), capacity, capital, collateral, and conditions. In terms of character, I have an above-average credit score of 789, which falls under the 740-799 range, which is described by Experian report as very good. I have never defaulted on a loan which makes my credit history faultless. Also, I keep my credit card balances at maximum and use them when it is necessary. In addition, I have kept my debts at a minimum. I would therefore not be categorized as a default risk by lending institutions. In terms of capacity, my debt-to-income ratio(DTI) is 34%, which is slightly below the 36%maximum for good capacity (Bankrate, 2018). The income from the business and other investments and the minimum debts have contributed to the low DTI. In addition, I have a house and a boat that can be used to secure a loan. I can, therefore, easily acquire secured loans provided the collateral can cover the loan amount. I also have investments and savings accounts that can help me obtain a loan and ensure I continue paying the debt if I lost the source of income. I intend to invest in real estate soon and increase the monthly investment savings to improve my capital, collateral, and capacity to acquire a loan.
Tim Clue's video on debt hilariously discusses the reality of debt. He describes the horrors of debt that individuals face daily. He jokes about receiving a call from debt collectors and credit card companies informing people about their debt status (Clue, 2007). However, though presented humorously, these calls from debt collectors usually make the debtors conscious of the sad reality of their credit status. They are reminded that debt has taken over their lives, and they are probably in a financial predicament they may not get out of soon. Debt is common, and many people have become slaves to credit card debts. Tim ends the skit by joking about how credit companies mail credit cards to random individuals who eventually find themselves in deep financial debt. These companies lure most people into debt.
References
Bankrate. (2018). Debt-To-Income Ratio Calculator . https://www.bankrate.com/calculators/mortgages/ratio-debt-calculator.aspx
Clue, T. (2007, July 24). Tim Clue on Debt [Video]. YouTube. https://www.youtube.com/watch?v=I5bbvMR8Ee4
Chen, J. (2021, April 16). Debt . Investopedia. https://www.investopedia.com/terms/d/debt.asp
