Debt is an integral part of people’s lives today. From credit cards to mortgage loans, consumer debt is essential to a country's economy. 

While debt can help you purchase important assets, such as a home and car, it’s also important to understand how it works and the pros and cons to ensure you’ll be able to use it responsibly. 

What Is Consumer Debt?

Consumer debt is a type of debt that individuals owe due to purchasing goods for household consumption. It’s also known as consumer credit and is measured as household debt (the total of all consumer debts and mortgage loans in a household).

On the other hand, non-consumer debts are generally business-related (business loans) or involuntary (tax debts). 

In some cases (like filing a bankruptcy), consumer debts can also be considered non-consumer obligations depending on how the funds were used. 

For example, if you borrow a student loan and use a significant portion of it to pay for living expenses rather than tuition fees, the loan is classified as non-consumer debt. 

Consumer debt can fall into two categories: secured debt and unsecured debt. 

A secured debt is a type of debt that’s backed by collateral. It acts as a security for the lender's investment, and if the borrower fails to repay the debt, the lender can legally seize and sell the collateral to collect the outstanding debt. 

Unsecured debt is not backed by collateral and is riskier for lenders. The lender can do little if the borrower defaults on the debt payments. Due to their risky nature, unsecured debts have higher interest rates. 

Lenders check several financial factors to assess your repayment capability before lending money: 

  • Credit score
  • Income
  • Credit history (previous loans, defaults, financial history, bank account statements, etc.)
  • Debt-to-income ratio (percentage ratio of all your monthly debts and your gross income. It should be no more than 35%)

Types of Consumer Debt

These are the most common types of consumer debts:

1. Credit Card Debt

The most common type of consumer debt which people come across is credit card debt.

Almost every adult in the country owns and uses a credit card in some capacity. These are mainly used for day-to-day purchases and paying monthly bills. In 2023, Americans had $1.13 trillion in credit card balances.

Credit cards are a form of revolving debt. This means that once you pay off the outstanding balance at the end of the month, the available balance replenishes. You can also make minimum payments on your credit card. However, the high interest rates charged on the remaining balance can be a double-edged sword. 

While credit cards are unsecured so the lender can’t seize your assets, it’s important to remember that lenders can still sue you for unpaid debts if the statute of limitations hasn’t passed.

The current average credit card interest rate is 27.91%, and the rates you qualify for depend on your credit score.

2. Personal Loans

A personal loan is an unsecured debt that can be borrowed for any type of financial need, such as medical bills, car repairs, or debt consolidation. You can borrow a personal loan from a bank, credit union, or online lender. For example, if you have multiple high-interest debts and you want to streamline payments, you can borrow a SoFi debt consolidation loan. 

It’s an installment debt where you receive a lump sum amount and repay it in fixed monthly installments. The duration of these loans ranges between 12 and 84 months, and current interest rates range from 7.49% to 29.99%. 

3. Mortgage Debt

Mortgage debt is a secured debt taken to purchase a property, where the property is the collateral. These are long-term debts with repayment terms of 15 to 30 years. 

It’s a leading source of debt for most Americans. In 2023, the U.S. had $12.25 trillion in mortgage debt. 

It’s important to remember that since mortgages are secured by the property if you fail to repay the loan as agreed, you risk foreclosure or short sale. 

4. Auto Loans

Also sometimes referred to as vehicle loans, auto loans are secured debts used to purchase vehicles (cars, trucks, boats, etc.). While the borrower owns the vehicle, it also serves as the collateral for the debt. 

It’s a short-term installment debt that usually lasts between 12 to 84 months. The average interest rate for new cars is 7.03% and 11.35% for used cars.

5. Student Loans

Along with mortgages and auto loan balances, student loans make up a large portion of debt in the U.S. Many students rely on federal student loans to pay for tuition. 

These are unsecured loans with a longer repayment term of usually ten or more years. There are also many repayment plans available for eligible borrowers. The interest in student loan payments is tax-deductible. 

It’s important to remember that there are some limitations when filing for bankruptcy when it comes to student loans. In most cases, bankruptcy doesn’t discharge student loans, so you’ll still have to repay them.

Advantages of Consumer Debt

Here are a few advantages of consumer debt:

Flexibility in Spending

The most significant advantage of consumer debt is easy access to money and flexibility to spend. Many people live paycheck-to-paycheck, and having an option like a credit card can help them pay for necessities without cash. 

A credit card's revolving debt ensures that a consumer can spend money and pay it back when they get their paycheck. If you clear your balance in full at the end of the billing cycle, you don’t have to pay interest. 

Help With Long-Term Financial Goals

Most people need more money than they can save for significant expenses like buying a house or paying college tuition. This is where consumer debt can help.

If you want to buy a home that costs $400,000, it’s easier to save for a 20% down payment and borrow a mortgage for the remaining amount than saving the entire amount. 

Similarly, student loan debt helps many people go through college and build a promising career. These loans make education accessible for the average person and provide equal opportunity. 

Cover Emergencies

Consumer debts such as personal loans help you manage unforeseen and necessary expenses. If you don’t have an emergency fund and your car breaks down, a personal loan can help you pay for it so you can continue to have a reliable vehicle to get to work.  

Improve Credit Score

On-time payment of your debt installments has a substantial positive impact on your credit score. A higher credit score makes it easier to qualify for loans and secure competitive interest rates.

Special Offers

You can access special offers with certain consumer debts like credit cards or auto loans. Perks such as discounts, airport lounge access, split payments, cash rewards, etc., are usually offered to borrowers with good credit scores. 

Boosts Economy

Credit encourages consumer spending, introducing more money into the economy. People use debts to manage their short and long-term financial needs, strengthening a country's economy. 

Risks of Consumer Debt

On the flip side, consumer debt has a few disadvantages as well, which we list below.

Overspending

Easy access to consumer loans may promote overspending. Some people may misjudge their financial condition and take on more debt than they can repay. 

This can eventually lead to a vicious cycle of debt resulting in bad credit, high delinquency rates, pestering by debt collectors, falling for predatory loan schemes, and even bankruptcy. 

High Fees

Some forms of consumer debt, such as credit cards and personal loans, have high interest rates, which can significantly impact your repayment ability. Long-term obligations such as mortgages and student loans offer low interest rates, but you’ll pay more over the life of the loan due to the longer repayment term.  

What Is Delinquency?

Delinquency is when a borrower does not pay back a debt. A loan is considered delinquent when repayments are not made consecutively for 90 days. As of December 2023, 3.1% of all outstanding debt in the U.S. was in delinquency.

Not repaying a loan can have serious consequences. It can damage your credit report and make it difficult to borrow in the future. Defaulting on a loan can also result in lawsuits, debt collection calls, and the creditor may seize your assets (secured debts).

Borrow Consumer Debt Responsibly

Regardless of the type of consumer debt you borrow, it’s important to weigh all your options, compare interest rates, and borrow only as much as you need. If you’re finding it difficult to keep up with payments on a loan, you may want to consider debt relief programs like debt settlement or consolidation.