Financial debt comes about when individuals and businesses borrow money from lenders. The lenders charge interest during the repayment of the borrowed money and make money on the transaction. People end up with debt from many sources as they borrow money from different types of lenders to use for a variety of purposes.
Consumer Spending
Credit card debt, auto loan debt and sometimes home equity debt fall under the broad category of debt due to personal spending. This is when people borrow money to pay for the purchase of an item that loses value over time. For example, paying for clothing on a credit card is personal spending debt. Home equity loans that are used to consolidate other types of consumer debt or to purchase items that will not gain value are also consumer spending.
Investment
Some people get into debt through an investment in the purchase of an asset that the borrower hopes will gain value over time. Mortgages are a prime example of investment debt because homeowners intend for their homes to increase in value, or at least hold their value, in the future. Student loans are also investment debt because borrowing for education increases the graduate's earning potential in the future.
Business
Especially in their early years, businesses borrow money to establish themselves and pay for business expenses while the income is low or nonexistent. The entrepreneur starting the business might have to take on debt as a personal loan at first, but once the business establishes its own credit, the business can apply for loans or get credit cards that are not tied to the credit of the business owner.
Other Classifications
Debts can be classified according to many schemes. For example, the categories of consumer spending debt and investment debt are sometimes referred to as bad debt and good debt. In another scheme, secured debts are tied to a particular asset, such as a house or a car, that the lender can sell to pay back the debt if the borrower does not make payments. Unsecured debts are those, such as credit cards and personal loans, that do not give the lender any right to the items purchased. Unsecured debts typically have higher interest rates than secured debts.
Lenders
The money for all of these types of debt has to come from somewhere, and this is where lenders come into the picture. Banks and credit unions make money on the deposits they hold by lending to individuals and businesses. Individual investors also finance debt by purchasing bonds and securities that are backed by different types of loans.
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