Product Code Database
Debt is an obligation that requires one party, the debtor, to pay money Loan 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 regarding the amount and timing of repayments of principal and interest. , bonds, notes, and Mortgage loan 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 morality 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.
People are likely to spend more and get into debt when they use credit cards as against cash to buy products and services.Chatterjee, P., & Rose, R. L. (2012). Do payment mechanisms change the way consumers perceive products? 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.Prelec, D. & Loewenstein, G. (1998). The red and the black: Mental accounting of savings and debt. Marketing Science, 17(1), 4-28.Raghubir, P. & Srivastava, J. (2008), Monopoly money: The effect of payment coupling and form on spending behavior . Journal of Experimental Psychology: Applied, 14 (3), 213–25. This is primarily because of the transparency effect and consumer's "pain of paying."Soman, D. (2003). The effect of payment transparency on consumption: Quasi experiments from the field . Marketing Letters, 14, 173–183. The transparency effect refers to the idea that the further you are from cash (as with a credit card or other forms of payment), 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.Chatterjee, P., & Rose, R. L. (2012). Do payment mechanisms change the way consumers perceive products? Journal of Consumer Research, 38(6), 1129–1139.
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".
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 "", 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 ; 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 (known as coupons) 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 (streets, sidewalks, stormwater ponds, etc.) 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 Unsecured debt 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 , "leveraging" the return on their Capital stock. 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.
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.Lew, Jacob (2016), America and the Global Economy , Foreign Affairs, May/June 2016. 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.
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.
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.
Debts owed by governments and private corporations may be rated by rating agencies, such as Moody's, Standard & Poor's, Fitch Ratings, and 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 refinancing depends on its creditworthiness. Bonds below Baa/BBB (Moody's/S&P) are considered High-yield debt 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.
Loans can be turned into securities through the securitization process. In a securitization, a company sells a pool of assets to a securitization trust, and the securitization trust finances its purchase of the assets by selling Debt securities to the market. For example, a trust may own a pool of home , and be financed by residential mortgage-backed securities. In this case, the asset-backed trust is a debt issuer of residential mortgage-backed securities.
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, odious debt is debt that is incurred by a regime for purposes that do not serve the interest of the state. Such debts are thus considered by this doctrine to be personal debts of the regime that incurred them and not debts of the state.
Excessive debt accumulation has been blamed for exacerbating economic problems. For example, before the Great Depression, the debt-to-GDP ratio was very high. 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 bankruptcy 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, 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.
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 Jubilee year, described in the Book of Leviticus. Similarly, in Deuteronomy chapter 15 and verse 1 states that debts be forgiven after seven years. This is because biblically debt is seen as the responsibility of both the creditor and the debtor. Traditional Christian teaching holds that a lifestyle of debt should not be normative; the Emmanuel Association, a 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)."
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