A debtor is any individual or institution that owes money to another individual or institution.
What is a Debtor?
The term “debtor” refers to an individual or institution that owes money, also known as having “debt.” Generally speaking, a debtor owes money because they have been issued a loan or line of credit. A debtor can also be referred to as a “borrower” if they have received a loan, or an “issuer” if the money owed is in the form of a security, like a bond.
How does being a Debtor work?
There are many ways in which a person or company can become a debtor, but most of them involve taking out a loan. A person can take out a loan from a bank or credit union, or they could take out a loan from a personal lender. They could take out a home mortgage loan to buy a house, or an auto loan to buy a car. They could also take out a line of credit.
A person could also become a debtor by taking out a credit card, because a credit card is basically a type of loan: it’s a line of credit that the debtor can directly access through their card. The person is expected to make payments on the credit card and eventually pay the entire amount back plus interest. Almost all loans and lines of credit come with interest. It’s how people and institutions that loan money, also known as “lenders” or “creditors”, are able to make money on their loan products and protect themselves from risk.
How does interest work?
Interest is money that a creditor charges to a debtor in order to borrow money. Essentially, the amount charged in interest amounts to the “cost” of the loan. Interest is usually charged as an interest rate: a certain percentage of the principal amount loaned that accrues over a set period of time. The standard interest rate is a yearly rate. For example, a $1,000 loan with a 10 percent interest rate would accrue $100 in interest if the principal were outstanding for an entire year.
A loan’s annual percentage rate (APR) measures how much a loan costs over the course of a single year. The APR is a better measure of true cost than the simple interest rate because the APR includes any additional fees that the lender has charged.
How does debt work?
There are two main kinds of debt that a debtor could take on: secured debt and unsecured debt.
When a person takes out a secured debt, they have to put something up as collateral. Collateral is any kind of valuable piece of personal property—everything from houses and cars to jewelry and antiques—that a lender can lay claim to if the debtor does not repay their debt. In the event that the debtor is unable to repay their loan or line of credit, their creditor can take ownership of their collateral and sell it in order to make up their losses. Because collateral offers lenders an additional level of security, secured loans often come with lower interest rates and more favorable terms for borrowers.
With an unsecured loan, there is no collateral. If the debtor is unable to repay their loan, the creditor stands to lose all the money that hasn’t been already paid back. Unsecured loans are then issued solely on whether or not the lender thinks that the debtor will be able to afford their loan. They often do this by looking at the borrower’s credit history, either by checking their credit report or their credit score. Because unsecured loans come with a much higher risk for lenders, they often come with higher rates and less favorable terms for borrowers.
How is debt structured?
When a debtor takes on debt, it will usually be either in the form of a loan or a line of credit.
Most loans, including personal, home, and auto loans, are structured as installment loans, which means that they are designed to be paid back over a pre-set period of time in a series of equal, regular installments. These loans are usually amortizing as well. With an amortizing loan, each payment goes towards both the principal amount loaned and the interest. This way, each payment pays down the amount owed and the loan is guaranteed to be fully paid off at the end of the loan’s repayment term.
However, some loans are not amortizing and are not installment loans. Many of these loans are short-term loans, which are meant to repaid in six months or less. Non-amortizing, short-term loans are not paid off in equal installments, they simply need to be repaid in full on or by the due date stated in the loan agreement.
With a line of credit, the debtor is not given a lump sum of money. Instead, they are given a maximum credit limit that they can borrow up to. The debtor can then borrow funds from the line as necessary and will only be charged interest on the funds they actually withdraw. Lines of credit are usually designed to be repaid in installments, but the amount of each payment can vary depending on the amount borrowed.
With a revolving line of credit, the debtor’s available credit will replenish as they pay down their balance. This means that a debtor who owes $2,000 against a $5,000 credit limit and makes a payment of $500 would then be able to borrow an additional $500 against that $5,000 limit. Credit cards are structured as lines of credit and most of them come with revolving balances.
Am I a debtor?
Probably. While not everyone owes debt, most people do. If you have a credit card, a mortgage, a car loan, student loans or payday loans, then you are a debtor. Even owing money on your utilities can be viewed as a kind of debtor-creditor relationship between you and your utility company. Almost everyone has debt, the question is whether or not you can manage your debt responsibly.