Debt

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Payday loan businesses lend money to customers, who then owe a debt to the payday loan company.

Debt is an obligation that requires one party, the

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.[2] 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."[3] 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.[4]

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

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 home, the creditor may seek to repossess the collateral. In more serious circumstances, individuals and companies may go into bankruptcy.

Types of giving finance

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 more likely to spend more and get into debt when they use credit cards vs. cash for buying products and services.[5][6][7][8][9] This is primarily because of the transparency effect and consumer's "pain of paying."[7][9] The transparency effect refers to the fact that the further you are from cash (as in a credit card or another form of payment), the less transparent it is and the less you remember how much you spent.[9] 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.[7] 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.[8][10]

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".[11]

Businesses

A company may use various kinds of debt to finance its operations as a part of its overall corporate finance strategy.

A

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

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

coupons
) during the life of the bond.

A

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.

Companies also use debt in many ways for

leverage
, the proportion of debt to equity, is considered important in determining the riskiness of an investment; the more debt per equity, the riskier.

Governments

treasury bond

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

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.[14]

Municipalities

Municipal bonds (or muni bonds) are typical debt obligations, for which the conditions are defined unilaterally by the issuing municipality (local government), but it is a slower process to accumulate the necessary amount. Usually, debt or bond financing will not be used to finance current operating expenditures, the purposes of these amounts are local developments, capital investments, constructions, own contribution to other credits or grants.[15]

Assessments of creditworthiness

Income metrics

The debt service coverage ratio is the ratio of income available to the amount of debt service due (including both interest and principal amortization, if any). The higher the debt service coverage ratio, the more income is available to pay debt service, and the easier and lower-cost it will be for a borrower to obtain financing.

Different debt markets have somewhat different conventions in terminology and calculations for income-related metrics. For example, in mortgage lending in the United States, a debt-to-income ratio typically includes the cost of mortgage payments as well as insurance and property tax, divided by a consumer's monthly income. A "front-end ratio" of 28% or below, together with a "back-end ratio" (including required payments on non-housing debt as well) of 36% or below is also required to be eligible for a conforming loan.

Value metrics

The loan-to-value ratio is the ratio of the total amount of the loan to the total value of the collateral securing the loan.

For example, in mortgage lending in the United States, the loan-to-value concept is most commonly expressed as a "down payment." A 20% down payment is equivalent to an 80% loan to value. With home purchases, value may be assessed using the agreed-upon purchase price, and/or an appraisal.

Collateral and recourse

A debt obligation is considered secured if creditors have recourse to specific collateral. Collateral may include claims on tax receipts (in the case of a government), specific assets (in the case of a company) or a home (in the case of a consumer). Unsecured debt comprises financial obligations for which creditors do not have recourse to the assets of the borrower to satisfy their claims.

Role of rating agencies

credit scores to evaluate the potential risk posed by lending money to consumers. In the United States, the primary credit bureaus are Equifax, Experian, and TransUnion
.

Debts owed by governments and private corporations may be rated by

A. M. Best. The government or company itself will also be given its own separate rating. These agencies assess the ability of the debtor to honor his obligations and accordingly give him or her a credit rating
. Moody's uses the letters Aaa Aa A Baa Ba B Caa Ca C, where ratings Aa-Caa are qualified by numbers 1-3. S&P and other rating agencies have slightly different systems using capital letters and +/- qualifiers. Thus a government or corporation with a high rating would have Aaa rating.

A change in ratings can strongly affect a company, since its cost of

creditworthiness. Bonds below Baa/BBB (Moody's/S&P) are considered junk or high-risk bonds. Their high risk of default (approximately 1.6 percent for Ba) is compensated by higher interest payments. Bad Debt is a loan that can not (partially or fully) be repaid by the debtor. The debtor is said to default
on their debt. These types of debt are frequently repackaged and sold below face value. Buying junk bonds is seen as a risky but potentially profitable investment.

Debt markets

Market interest rates

Loans versus bonds

Bonds are debt securities, tradeable on a bond market. A country's regulatory structure determines what qualifies as a security. For example, in North America, each security is uniquely identified by a CUSIP for trading and settlement purposes. In contrast, loans are not securities and do not have CUSIPs (or the equivalent). Loans may be sold or acquired in certain circumstances, as when a bank syndicates a loan.

Loans can be turned into securities through the

mortgages, and be financed by residential mortgage-backed securities. In this case, the asset-backed trust is a debt issuer of residential mortgage-backed securities
.

Role of central banks

Federal Reserve System, play a key role in the debt markets. Debt is normally denominated in a particular currency, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation, so it can happen even though the borrower and the lender are using the same currency
.

Criticisms

Some argue against debt as an instrument and institution, on a personal, family, social, corporate and governmental level. Some

Islamic banking
forbids lending with interest even today. In hard times, the cost of servicing debt can grow beyond the debtor's ability to pay, due to either external events (income loss) or internal difficulties (poor management of resources).

Debt with an associated interest rate will increase through time if it is not repaid faster than it grows through interest. This effect may be termed usury, while the term "usury" in other contexts refers only to an excessive rate of interest, in excess of a reasonable profit for the risk accepted.

In international legal thought,

developing nations.[citation needed
]

Excessive debt accumulation[clarification needed] has been blamed for exacerbating economic problems[by whom?]. For example, before the Great Depression, the debt-to-GDP ratio was very high.[citation needed] Economic agents were heavily indebted.[clarification needed] This excess of debt, equivalent to excessive expectations on future returns, accompanied asset bubbles on the stock markets. When expectations corrected, deflation and a credit crunch followed. Deflation effectively made debt more expensive and, as Fisher explained, this reinforced deflation again, because, in order to reduce their debt level, economic agents reduced their consumption and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost caused by deflation and the reduced demand.

At the household level, debts can also have detrimental effects — particularly when households make spending decisions assuming income will increase, or remain stable, in years to come. When households take on credit based on this assumption, life events can easily change indebtedness into over-indebtedness. Such life events include unexpected unemployment, relationship break-up, leaving the parental home, business failure, illness, or home repairs. Over-indebtedness has severe social consequences, such as financial hardship, poor physical and mental health,[16] family stress, stigma, difficulty obtaining employment, exclusion from basic financial services (European Commission, 2009), work accidents and industrial disease, a strain on social relations (Carpentier and Van den Bosch, 2008), absenteeism at work and lack of organisational commitment (Kim et al., 2003), feeling of insecurity, and relational tensions.[17]

Levels and flows

Global debt underwriting grew 4.3 percent year-over-year to US$5.19 trillion during 2004.[citation needed]

History

According to historian Paul Johnson, the lending of "food money" was commonplace in Middle Eastern civilizations as early as 5000 BC.[citation needed]

Religions like Judaism and Christianity for example, demand that debt be forgiven on a regular basis, in order to prevent systemic inequities between groups in society, or anyone becoming a specialist in holding debt and coercing repayment. An example is the Biblical

Methodist denomination in the conservative holiness movement, for example, teaches: "We are to refrain from entering into debt when we have no reasonable plan to pay. We are to be careful to meet all financial engagements promptly when due, if at all possible, remembering that we are to 'Provide things honest in the sight of all men' and to 'owe no man any thing, but to love one another' (Romans 12:17; 13:8)."[20]

Further reading

See also

References

  1. ^ Superior Court of Pennsylvania (1894). "Brooke et al versus the City of Philadelphia et al". Weekly Notes of Cases Argued and Determined in the Supreme Court of Pennsylvania, the County Courts of Philadelphia, and the United States District and Circuit Courts for the Eastern District of Pennsylvania. 34 (18). Kay and brother: 348.
  2. ^ "debt". Oxford English Dictionary (Online ed.). Oxford University Press. (Subscription or participating institution membership required.)
  3. ^ "Debt". www.etymonline.com. Online Etymology Dictionary. Archived from the original on 10 August 2017. Retrieved 20 May 2017.
  4. ^ Chen, James. "Principal". Investopedia. Archived from the original on 17 December 2021. Retrieved 1 August 2020.
  5. ^ Chatterjee, P., & Rose, R. L. (2012). Do payment mechanisms change the way consumers perceive products? Archived 12 September 2015 at the Wayback Machine Journal of Consumer Research, 38(6), 1129–1139.
  6. ^ Pettit, N. C., & Sivanathan, N. (2011). The plastic trap. Social Psychological and Personality Science, 2(2), 146-153.
  7. ^ a b c Prelec, D. & Loewenstein, G. (1998). The red and the black: Mental accounting of savings and debt. Marketing Science, 17(1), 4-28.
  8. ^ a b Raghubir, P. & Srivastava, J. (2008), Monopoly money: The effect of payment coupling and form on spending behavior Archived 15 February 2015 at the Wayback Machine. Journal of Experimental Psychology: Applied, 14 (3), 213–25.
  9. ^ a b c Soman, D. (2003). The effect of payment transparency on consumption: Quasi experiments from the field Archived 19 February 2018 at the Wayback Machine. Marketing Letters, 14, 173–183.
  10. ^ Chatterjee, P., & Rose, R. L. (2012). Do payment mechanisms change the way consumers perceive products? Journal of Consumer Research, 38(6), 1129–1139.
  11. ^ "Household over-indebtedness in the EU: The role of informal debts" (PDF). eurofound.europa.eu. Publications Office of the European Union, Luxembourg. 2013. Archived (PDF) from the original on 8 December 2014. Retrieved 19 April 2016.
  12. ^ Uzialko, Adam. "Using Revenue-Based Financing to Grow Your Business". Business News Daily. Archived from the original on 1 November 2017. Retrieved 5 December 2018.
  13. ^ Lew, Jacob (2016), America and the Global Economy Archived 3 December 2018 at the Wayback Machine, Foreign Affairs, May/June 2016.
  14. ^ "Goal 17 | Department of Economic and Social Affairs". sdgs.un.org. Archived from the original on 2 November 2021. Retrieved 26 September 2020.
  15. from the original on 14 April 2021. Retrieved 27 December 2020 – via REAL-MTAK.
  16. .
  17. ^ Dubois, Hans; Anderson, Robert (2010). "Managing household debts: Social service provision in the EU. Working paper. Dublin: European Foundation for the Improvement of Living and Working Conditions" (PDF). European Foundation for the Improvement of Living and Working Conditions. Archived (PDF) from the original on 27 November 2017. Retrieved 20 February 2015.
  18. .
  19. ^ "Jubilee USA: Debt Cancellation: A Biblical Norm". www.jubileeusa.org. Archived from the original on 3 October 2020. Retrieved 22 September 2020.
  20. Emmanuel Association
    . 2002. pp. 13–14.
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