Consumer debt refers to consumer credit that is outstanding. In the language of macroeconomics, consumer debt is used for funding consumption instead of investment.
Consumer debt, in modern times is viewed as a means for increasing domestic production. Easy availability of credit means increase in the demand for consumer goods thus causing higher domestic overall production. A hypothesis relating to permanent income suggests that consumers may take debts for smooth consumption across their lives – borrowing in order to finance expenditures, especially housing as well as schooling in their early lives, and repaying the debt in periods of higher earning.
Types of consumer debt
Barring mortgage and education loans, consumer debt is taken to be an evil as it has a tendency to eat into an individual’s net worth, encouraging a person to lead a lifestyle beyond one’s means. Certain types of consumer debt include:
• Credit Card: This is a form of plastic card that is issued by a bank, permitting the cardholder to pay for products and services without the use of credit cardholder’s money. The issuer of the credit card initially pays the service provider or the merchant and subsequently sends a detailed monthly statement to the cardholder showing the services and purchases bought by the cardholder. The cardholder is supposed to repay the amount within a specified time to the credit card issuer. There is also a maximum credit limit set for different cardholders. Each credit card comes with an annual percentage rate. If you fail to clear off the outstanding balance in the interest–free period of the card, interest will be charged on the remaining balance. However, if you have withdrawn cash against your credit card, there is generally no interest–free period. You will be charged interest from the time of your withdrawal.
• Overdraft: This is an ideal way to borrow small amount of cash for a short time period. A current account or a savings account can come with the facility of overdraft. This gives the accountholder the right to spend a higher amount than the balance present in his/her account. Thus the bank’s money is being made use of with the bank charging certain rate of interest for this. However you must be careful to limit your spending so that it does not exceed the stated limit of overdraft.
• Personal loan: It is a form of consumer debt taken for the purpose of own/individual use. The purpose of this loan is not stated clearly in the agreement unlike automobile or mortgages loan. You can consider consolidating your debt with a personal loan. This type of loan is ideal for medium borrowing or long term and is cheaper in comparison to overdraft.
Mortgage loans and automotive loans are other forms of consumer debts, with the former being the most expensive consumer debt.
Debt counseling can be of great help to individuals burdened with considerable amounts of consumer debt. National Foundation for Credit Counseling and LSS Financial Counseling Service are two good sources to look for information on consumer debt.