Debt
Debt is an obligation that requires one party, the debtor, to pay money borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of [|principal] and interest. Loans, bonds, notes, and mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity.
The term can also be used metaphorically to cover moral obligations and other interactions not based on a monetary value. For example, in Western cultures, a person who has been helped by a second person is sometimes said to owe a "debt of gratitude" to the second person.
Etymology
The English term "debt" was first used in the late 13th century and comes by way of Old French from the Latin verb debere, "to owe; to have from someone else." The related term "debtor" was first used in English also in the early 13th century.Terms
Principal
Principal is the amount of money originally invested or loaned, on which basis interest and returns are calculated.Repayment
There are three main ways repayment may be structured: the entire principal balance may be due at the maturity of the loan; the entire principal balance may be amortized over the term of the loan; or the loan may be partially amortized during its term, with the remaining principal due as a "balloon payment" at maturity. Amortization structures are common in mortgages and credit cards.Default provisions
Debtors of every type default on their debt from time to time, with various consequences depending on the terms of the debt and the law governing default in the relevant jurisdiction.If the debt was secured by specific collateral, such as a car or house, the creditor may seek to repossess the collateral. In more serious circumstances, individuals and companies may go into bankruptcy.
Types of borrowers
Individuals
Common types of debt owed by individuals and households include mortgage loans, car loans, credit card debt, and income taxes. For individuals, debt is a means of using anticipated income and future purchasing power in the present before it has actually been earned. Commonly, people in industrialized nations use consumer debt to purchase houses, cars and other things too expensive to buy with cash on hand.People are likely to spend more and get into debt when they use credit cards as against cash to buy products and services. This is primarily because of the transparency effect and consumer's "pain of paying." The transparency effect refers to the idea that the further you are from cash, the less transparent it is and the less aware you are of how much you have spent. The less transparent or further away from cash the form of payment employed is, the less an individual feels the "pain of paying" and thus is likely to spend more. Furthermore, the differing physical appearance/form that credit cards have from cash may cause them to be viewed as "monopoly" money vs. real money, luring individuals to spend more money than they would if they only had cash available.
Besides these more formal debts, private individuals also lend informally to other people, mostly relatives or friends. One reason for such informal debts is that many people, in particular those who are poor, have no access to affordable credit. Such debts can cause problems when they are not paid back according to expectations of the lending household. In 2011, 8 percent of people in the European Union reported their households has been in arrears, that is, unable to pay as scheduled "payments related to informal loans from friends or relatives not living in your household".
Businesses
A company may use various kinds of debt to finance its operations as a part of its overall corporate finance strategy.A term loan is the simplest form of corporate debt. It consists of an agreement to lend a fixed amount of money, called the principal sum or principal, for a fixed period of time, with this amount to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per year, will also have to be paid by that date, or may be paid periodically in the interval, such as annually or monthly. Such loans are also colloquially called "bullet loans", particularly if there is only a single payment at the end – the "bullet" – without a "stream" of interest payments during the life of the loan.
A revenue-based financing loan comes with a fixed repayment target that is reached over a period of several years. This type of loan generally comes with a repayment amount of 1.5 to 2.5 times the principle loan. Repayment periods are flexible; businesses can pay back the agreed-upon amount sooner, if possible, or later. In addition, business owners do not sell equity or relinquish control when using revenue-based financing. Lenders that provide revenue-based financing work more closely with businesses than bank lenders, but take a more hands-off approach than private equity investors.
A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan. A syndicated loan is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers. Loan syndication is a risk management tool that allows the lead banks underwriting the debt to reduce their risk and free up lending capacity.
A company may also issue bonds, which are debt securities. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common. At the end of the bond's life the money should be repaid in full. Interest may be added to the end payment, or can be paid in regular installments during the life of the bond.
A letter of credit or LC can also be the source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and traveler's cheque. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and a document proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.
Debt consolidation is a process whereby a new, large loan application is submitted in order to compensate for numerous outstanding loans. Some amongst those who are heavily indebted often resort to debt consolidation as a means to resolve their financial difficulties. Upon obtaining the borrowed loan, those within the receiving end are then generally enabled to have a greater cash flow, resulting from lowering monthly payments, if not reducing interest rates. However, this varies from every claimant, in that their own eligibility for such is entirely dependent on their own overall circumstances; Should they meet specific requirements, being able to afford such, their requests are usually accepted; Should they fail the criteria, they're almost always swiftly rejected, regardless of their financial ability. Given the often monetary hardship of contenders, those providing these loans often charge at larger rates of interest than others; This is often critiqued by its opponents, who claim that it is an unfair practice aimed at targeting those who are desperate and often holds arbitrary figures, although those in its defence claim it is a security measure aimed at ensuring its repayment obligations and must take precautions before offering large sums. Both arguments have resulted in greater debate amongst legislators in different nations, amidst demands for further regulation and more decreases in lending restrictions. Debt consolidation has also been an area of interest for loan sharks, leaving those heavily indebted vulnerable to extortionate rates. The idea behind debt consolidation is occasionally a matter of debate in the financial and institutional sectors, often ranging between analysts towards professors, generally concerning ethics involved in different areas.
Companies also use debt in many ways for capital expenditures and other business investments produced in their assets, "leveraging" the return on their equity. This leverage, the proportion of debt to equity, is considered paramount in determining the riskiness of an investment, under the notion that it becomes more risking under more debt.
Governments
Governments issue debt to pay for ongoing expenses as well as major capital projects. Government debt may be issued by sovereign states as well as by local governments, sometimes known as municipalities.Debt issued by the government of the United States, called Treasuries, serves as a reference point for all other debt. There are deep, transparent, liquid, and open capital markets for Treasuries. Furthermore, Treasuries are issued in a wide variety of maturities, from one day to thirty years, which facilitates comparing the interest rates on other debt to a security of comparable maturity. In finance, the theoretical "risk-free interest rate" is often approximated by practitioners by using the current yield of a Treasury of the same duration.
The overall level of indebtedness by a government is typically shown as a ratio of debt-to-GDP. This ratio helps to assess the speed of changes in government indebtedness and the size of the debt due.
The United Nations Sustainable Development Goal 17, an integral part of the 2030 Agenda has a target to address the external debt of highly indebted poor countries to reduce debt distress.