What is debt? Definition and meaning

Debt refers to something – either metaphorical or physical – that is owed or due. The party that receives the debt is known as the borrower, while the party to whom the debt is owed or due is called the lender. In the physical sense, if you have a debt it could mean money that you owe to your bank, while in metaphorical sense it refers to, for example a moral obligation, as in a debt of gratitude.

A common term meaning the receiver of a debt – the one that owes – is a debtor, while the one that is owed is typically called the creditor.

Debt has been around considerably longer than money or coinage. Historians say examples of debt, used for commerce (barter system), date back to about 2,900 years before the invention of coinage.

What is debt?Debts comes in many forms. This image shows an example of a bank lending a customer money to buy a car (car loan), and a well-off lady lending money to her nephew.

Many types of debt

Physical debt today can take many different forms; examples of lenders of monetary debt include credit card firms, banks, payday loan providers, sovereign nations, individuals, and even local governments and councils.

According to Dictionary.com, a debt is:

“1. Something that is owed or that one is bound to pay to or perform for another (a debt of $50). 2. A liability or obligation to pay or render something (My debt to her for advice is not to be discharged easily). 3. The condition of being under such an obligation (His gambling losses put him deeply in debt). 4. Theology. an offense requiring reparation (a sin, a trespass).”

People, companies and governments use debt as a method of making large purchases or completing major projects that under normal circumstances they could not afford. In a debt arrangement, the borrowing party has permission to borrow money under the condition that the amount owed is to be paid back at a later date – either all in one sum, or at regular intervals, usually with interest.

Interest is an accepted way to ensure that the lender is compensated for bearing the risk of the loan – it also encourages the borrower to pay back quickly in order to keep his or her total interest expense down to a minimum.

Global debt time bombMany economists, investors and financiers fear that a global debt crisis is imminent. Some say it will cause the most severe worldwide financial meltdown ever.

Today, loans are the most common forms of debt, and may include a checking account overdraft, credit card debt, mortgages, student loans, personal loans, small business loans, payday loans, consolidated loans, etc.

Good and Bad Debt

Investors and financiers pay a lot of attention to the amount of debt companies have. A firm that has a lot of debt might struggle to pay its interest payments if sales decline, a situation that could push the whole business into bankruptcy. On the other hand, companies with no debt at all could be missing out on major expansion opportunities.

The optimum amount of debt varies considerably from sector to sector. Utility and financial services companies typically have high debts in relation to their equity (debt-to-equity ratios), while service industries and wholesalers have relatively low debt ratios.

A bad debt is one that will not be paid back. Businesses write off bad debts usually as expenses. Bad debts are also called bad loans or delinquent loans. Expenses are what companies, individuals and organizations spend.

Debt default

Borrowers sometimes default on their debt – they fail to pay it back or keep up with their monthly or yearly repayment installments. Consequences for defaulting vary, depending on the terms of the debt and the laws of that country.

Borrowers who have defaulted before usually have to pay higher interest rates to compensate for the greater risk for the lender. Banks and other lenders assess the risk of default before making a loan, usually through a system of credit scores and corporate and sovereign ratings.

Companies and individuals may go into bankruptcy if they are unable to meet the terms of the debt agreement. Experts say that international third world debt has reached a scale that the only way to prevent a series of global economic crises is to cancel (write off) some of those loans.

Forms of debtGratitude – the mother of the girl on the left might say: “We would like to thank the brave and wonderful firefighter who saved our daughter’s life. We shall be forever in his debt.” Money owed – the man on the right might say: “With this last payment, my debt will be settled.”

Debt quotes

Below are some quotes said by famous people.

– “What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” (Adam Smith,  1723-1790. A Scottish moral philosopher and pioneer of political economy. He is known in the Western World as the father of modern economics.)

– “Nobody had a credit card when I was a kid. No one had credit card debt. But these big companies and banks wanted to know how to get more money out of people – get them charging things.” (Michael Moore, an American documentary filmmaker and author.)

– “The cost of college education today is so high that many young people are giving up their dream of going to college, while many others are graduating deeply in debt.” (Bernie Sanders, an American politician who has served as the junior United States Senator from Vermont since 2007. He had been the longest-serving independent in U.S. congressional history.)

– “Without this playing with fantasy no creative work has ever yet come to birth. The debt we owe to the play of the imagination is incalculable. (Carl Jung , 1875-1961, a Swiss psychiatrist and psychotherapist who founded analytical psychology.)

– “My husband has quite simply been my strength and stay all these years, and I owe him a debt greater than he would ever claim.” (Queen Elizabeth II)

– “Rather go to bed with out dinner than to rise in debt.” (Benjamin Franklin, 1706-1790, one of the Founding Fathers of the United States. He was a leading author, politician, inventor, printer, political theorist, freemason, postmaster, scientist, civic activist, statesman, and diplomat.)

– “The first thing, when I got the money, I knew I would support somebody. And the person I supported was my family. Because we were really in debt with the money. And – so I gave to my father this suitcase full of money. And he couldn’t believe it. And that was something very special.” (Michael Schumacher, a German retired racing driver. He is a 7-time Formula One World Champion – widely regarded as one of the greatest Formula One drivers ever.)

– “Getting a family into work, supporting strong relationships, getting parents off drugs and out of debt – all this can do more for a child’s well-being than any amount of money in out-of-work benefits.” (Iain Duncan Smith, a British Conservative Party politician.)

Video – What is debt?

In this Mashable video, Kal Penn explains what debt is. According to him, there are two kinds, and they are not worth fretting about.