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Definitions & Components of Debt

What is Debt?

When you borrow money, you enter the world of debt. It has rules, players and strategies. One of the best things you can do for yourself is to learn how to use debt well. Below are some important definitions and components which you should know about:

Definitions

Debt: What you owe when you borrow something—cash or tangible goods from someone else, or when you purchase on credit.

When you borrow money from another person or institution (such as a bank or credit union), the lender expects to be repaid. Usually the person who lends the money charges a fee for the use of that money.

One can be in debt to family members, friends, informal lenders or financial institutions.

Sample sentences using the word debt:

1. After borrowing money to purchase a refrigerator, Rashid is in debt to his father.

2. With a loan for school fees and another one for her business, Sarah is carrying as much debt as she can afford.

Loan: Something lent for the borrower’s temporary use. Commonly, a loan refers to a sum of money that a lender gives to a borrower for a certain period of time. The borrower makes a commitment to repay the money with interest.

For the borrower, the loan is a liability (a sum that is owed). This debt must be repaid regardless of income or cash flow.

Sample sentences using the word Loan:

1. Fatima has a small loan from her village bank that she must repay in four months.

2. The government program makes in-kind loans of seeds that farmers repay in produce at harvest time.

Credit: The ability to borrow, or the sum available for borrowing.

Banks and other financial institutions will approve credit to customers who have a good record of repaying their loans on time. Purchasing ―on credit means getting the item you want without fully paying for it at the time of purchase. The buyer makes a commitment to pay for the item in installments or on a certain date in the future.

Sample sentences using the word Credit:

1. Because Khalid repaid his last loan on time, he has a good credit standing at the bank.

2. Shopkeepers should only sell on credit to those customers they know and can trust.

Default: Failure to pay back a loan.

Sample sentences using the word Default:

1. Shehnaz defaulted on her loan after her husband was injured in a car accident and she had hospital bills to pay.

2. Abdul Rauf borrowed money from his brother to pay back his bank loan and avoid defaulting.

Components of Credit

If you borrow money from a bank or other formal lender, you will hear the following terms associated with your loan. It will be important to understand what each means for your specific loan.

Loan size: The amount you borrow.

Loan term: Period of time you have to use the loan money and repay it.

Interest rate: Percentage of the total loan amount charged to the borrower for the use of money borrowed. Interest is usually charged on a monthly basis.

Fees: Administrative charges in addition to interest which are usually paid once, at the time the borrower takes the loan.

Grace period: Period after receiving a loan and before the first payment is due.

Repayment schedule: The frequency of loan payments (e.g., weekly, biweekly, monthly).