Debt is the amount of money that one party, called the borrower or debtor, borrows from another party, called the lender or creditor. Debt is supposed to be paid back, with interest, at a later date agreed upon by the two parties.
An individual taking a loan from a bank is said to be in debt and is supposed to pay back the loan along with interest at a future date.
An individual taking a loan from a bank is said to be in debt and is supposed to pay back the loan along with interest at a future date. These loans can be taken by an individual, a business undertaking, or by the Government.
What are the types of debt?
The various types of debts are:-
- Mortgages:- when one mortgages an asset to take a loan against it. The most common form is keeping a home on mortgage
- Secured debt:- In this, the debt is secured by a collateral asset. In case the borrower is not able to repay the loan amount, the lender has the authority to take charge of the asset. Secured creditors come first in the list of creditors to be paid when a business is declared insolvent
- Unsecured debt:- In this the loan is given solely on the basis of trust, and in case of default there is a total loss if the company is not left with enough funds after payment of secured creditors and preferential shareholders
- Loans & credit cards:- It includes bank loans. In credit cards, the person can spend up to the limit of the card. This limit is generally based on the financial score of an individual and his past payment records.
What is the role of rating agencies in the debt market?
It is essential to know the creditworthiness of a company before lending money to it. All the credit rating agencies such as CRISIL, S&P rates the debtor. The rating starts from AAA (this being the best) to D (this being the worst). Bonds below the grade of BBB or BB are considered as high-risk instruments but are compensated with high-interest payments. Maintaining a good credit rating is important as a lower rating leads to an increase in the cost of refinancing, which increases interest payments, thereby reducing the net profits of the company.