Debt
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Debt is an obligation that requires one party, the
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
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
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
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
A
Companies also use debt in many ways for
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
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
Debts owed by governments and private corporations may be rated by
A change in ratings can strongly affect a company, since its cost of
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
Role of central banks
Criticisms
Some argue against debt as an instrument and institution, on a personal, family, social, corporate and governmental level. Some
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,
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
Further reading
- World Bank, 2019. Global Waves of Debt: Causes and Consequences. Edited by M. Ayhan Kose, Peter Nagle, Franziska Ohnsorge, and Naotaka Sugawara.
See also
- Debt theory of money
- Debt deflation
- World debt
References
- ^ 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.
- ^ "debt". Oxford English Dictionary (Online ed.). Oxford University Press. (Subscription or participating institution membership required.)
- ^ "Debt". www.etymonline.com. Online Etymology Dictionary. Archived from the original on 10 August 2017. Retrieved 20 May 2017.
- ^ Chen, James. "Principal". Investopedia. Archived from the original on 17 December 2021. Retrieved 1 August 2020.
- ^ 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.
- ^ Pettit, N. C., & Sivanathan, N. (2011). The plastic trap. Social Psychological and Personality Science, 2(2), 146-153.
- ^ 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.
- ^ 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.
- ^ 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.
- ^ Chatterjee, P., & Rose, R. L. (2012). Do payment mechanisms change the way consumers perceive products? Journal of Consumer Research, 38(6), 1129–1139.
- ^ "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.
- ^ 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.
- ^ Lew, Jacob (2016), America and the Global Economy Archived 3 December 2018 at the Wayback Machine, Foreign Affairs, May/June 2016.
- ^ "Goal 17 | Department of Economic and Social Affairs". sdgs.un.org. Archived from the original on 2 November 2021. Retrieved 26 September 2020.
- from the original on 14 April 2021. Retrieved 27 December 2020 – via REAL-MTAK.
- .
- ^ 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.
- ISBN 978-3981826029.
- ^ "Jubilee USA: Debt Cancellation: A Biblical Norm". www.jubileeusa.org. Archived from the original on 3 October 2020. Retrieved 22 September 2020.
- Emmanuel Association. 2002. pp. 13–14.