PERSONAL FINANCE

Midterm Handouts
Prepared by: Valerie D. Balais

DEBT
Debt is something, usually money, owed by one party to another. Debt is used by many
individuals and companies to make large purchases that they could not afford under other
circumstances. Unless a debt is forgiven by the lender, it must be paid back, typically with added
interest.
The most common forms of debt are loans, including mortgages, auto loans, and personal loans,
as well as credit cards. Under the terms of a most loans, the borrower receives a set amount of
money, which they must repay in full by a certain date, which may be months or years in the
future. The terms of the loan will also stipulate the amount of interest that the borrower is
required to pay, expressed as a percentage of the loan amount. Interest compensates the lender
for taking on the risk of the loan.
Credit cards and lines of credit operate a little differently. They provide what's known as
revolving or open-end credit, with no fixed end date. The borrower is assigned a credit limit and
they can use their credit card or credit line repeatedly as long as they don't exceed that limit.

Types of Consumer Debt

Debt can come in a variety of forms, each with their own uses and requirements. Most types of
debt fall into one or more of the following categories:

Secured Debt
Secured debt is also known as collateralized debt. That means the borrower has pledged
something of value to back up the debt. With a car loan, for example, the vehicle usually serves
as collateral. If the borrower fails to repay the money they borrowed to buy the car, the lender
can seize and sell it. Similarly, when someone takes out a mortgage to buy a home, the home
itself typically serves as collateral. If the borrower fails to make payments, the lender
can foreclose and take the home.
A company that wants to borrow money might pledge a piece of machinery, real estate, or cash
in the bank as collateral.

Unsecured Debt
Unsecured debt does not require any collateral as security. Instead, the lender decides whether to
grant a loan based on the borrower's creditworthiness, as indicated by their credit score, credit
history, and other factors.
Most credit cards and most personal loans are examples of unsecured debt. Because unsecured
debt can be riskier to the lender it generally commands a higher interest rate than secured debt.
Revolving Debt
Revolving debt provides the borrower with a line of credit that they are able to borrow from as
they wish. The borrower can take up to a certain amount, pay the debt back, and borrow up to
that amount again. The most common form of revolving debt is credit card debt.
As long as the borrower fulfills their obligations, typically by making monthly payments of at
least a certain minimum amount, the line of credit remains available for as long as the account is
active. Over time, with a favorable repayment history, the amount of revolving debt that's
available to the borrower may increase.

Mortgages
A mortgage is a type of secured debt used to purchase real estate, such as a house or condo.
Mortgages are usually paid back over long periods, such as 15 or 30 years.
Mortgages are often the largest debt, apart from student loans, that consumers will ever take on,
and they come in many different varieties. Two broad categories are fixed-rate
mortgages and adjustable-rate mortgages, or ARMs. In the case of ARMs, the interest rate can
change periodically, usually based on the performance of a particular index.

Advantages and Disadvantages of Debt

Properly used, debt can be advantageous to individuals and companies alike. Few people could
buy a home without a mortgage, and many people couldn't afford a new car without an auto loan.
Credit cards can be a great convenience and even a lifesaver in emergency situations.
For companies, access to debt can make all the difference in their ability to expand and compete.
But debt can be risky, for borrower and lender alike. With enough credit cards in their wallets,
consumers can easily accumulate an unmanageable amount of debt, especially if they lose their
jobs or face another serious setback.
Companies that take on a large amount of debt may not be able to make their interest payments if
sales drop, putting the business in danger of bankruptcy. Even if it doesn't reach that point,
having too much debt can impose a crippling burden on a company, requiring it to devote much
of its income to debt repayment rather than more productive purposes.
Difference Between Debt and a Loan
Debt and loan are often used synonymously, but there are slight differences. Debt is anything
owed by one person to another. Debt can involve real property, money, services, or other
consideration.
A loan is a form of debt but, more specifically, an agreement in which one party lends money to
another. The lender sets repayment terms, including how much is to be repaid and when, as well
as the interest rate on the debt.
Difference Between Debt and Credit
Debt is amount of money you owe, while credit is the amount of money you have available to
you to borrow. For example, unless you have maxed out your credit cards, your debt is less than
your credit.
Debt is an important, if not essential, tool in today's economy. Businesses take on debt in order to
fund needed projects, while consumers may use it to buy a home or finance a college education.
At the same time, debt can be risky, especially for companies or individuals that accumulate too
much of it.

Good Debt
If the debt you take on helps you generate income or build your net worth, then that can be
considered “good.” Loans like mortgages are usually considered good debt because they provide
value to the borrower by helping them build wealth. Going into debt may be beneficial to your
overall financial health in several types of scenarios, such as paying for an education, funding a
business, or buying a home.
Examples of "Good Debt"
Debt that helps put you in a better position may be considered "good debt." Borrowing to invest
in a small business, education, or real estate is generally considered “good debt” because you're
investing the money you borrow in an asset that will improve your overall financial situation.
Bad Debt
Bad debt is generally considered money that you borrowed to purchase a depreciating asset.
Debt that isn't healthy for your finances typically carries a high interest rate. Carrying too much
debt can negatively affect your credit score.
Examples of "Bad Debt"
High-interest loans, such as those from payday lenders or credit cards, are expensive but can
make sense in particular circumstances. A loan is generally considered bad debt if you're
borrowing to purchase a depreciating asset. In other words, if it won’t go up in value or generate
income, then you shouldn’t go into debt to buy it. This includes clothes, cars, and most
other consumer goods.

Debt Management
Debt management is the process of planning your debt liabilities and repayments. You can do
this yourself, or use a third-party negotiator (usually called a credit counselor). This person or
company works with your lenders to negotiate lower interest rates and combine all your debt
payments into one monthly payment. This may be part of a debt management plan
(DMP) established to repay your balances, if needed.
Debt management plans (DMPs) generally exclude secured loans, like mortgages and auto loans,
and some types of unsecured loans, like student loans.
Understanding Credit Cards
Credit cards are a ubiquitous part of modern financial life, but understanding them can
sometimes be a challenge. A credit card is a payment card issued by a financial institution,
typically a bank, that allows cardholders to borrow funds with which to pay for goods and
services. The borrowed money must be paid back within a certain period of time, often with
interest.
Why Use a Credit Card?
Credit cards offer several benefits. They provide a convenient way to pay for purchases, both in-
person and online. They can also be a useful tool for managing cash flow, as they allow you to
make purchases now and pay for them later.
In addition, many credit cards offer rewards programs, where you earn points, miles, or cash
back for every dollar you spend. These rewards can be redeemed for a variety of things, such as
travel, merchandise, or statement credits.
Furthermore, using a credit card responsibly can help you build a good credit history, which can
be beneficial when you're applying for loans, renting an apartment, or even applying for a job.

How Does a Credit Card Work?

When you apply for a credit card, the issuer will evaluate your creditworthiness – that is, your
ability to repay the money you borrow. This is typically done by checking your credit score and
reviewing your credit report.
If you're approved for a credit card, you'll be given a credit limit, which is the maximum amount
you can borrow at any one time. Each time you make a purchase with your credit card, that
amount is added to your balance, which is the total amount you owe.
At the end of each billing cycle, you'll receive a statement showing your balance, as well as any
interest and fees that have been added. You'll need to make at least the minimum payment by the
due date to avoid late fees and potential damage to your credit score.
In conclusion, credit cards are a powerful financial tool. They offer convenience, rewards, and
the opportunity to build credit. However, they also come with responsibilities. To avoid costly
fees and interest charges, it's important to use credit cards wisely and pay your balance in full
and on time whenever possible.

Credit Card Do’s and Don’ts

Do’s
1. Pay your bill on time to avoid charges.
2. Pay your balance in full to avoid interest.
3. Review your credit card statements regularly
4. Reduce your credit limit if you are tempted to overspend.
5. Protect yourself from credit card fraud.
Don’ts
1. Don’t own too many credit cards at one time.
2. Don’t depend on credit cards to make ends meet.
3. Avoid big-item purchases with your credit card (unless you can actually pay the balance
in full with cash).
4. Don’t pick the first credit card you see without checking other options.
5. Don’t treat your credit card as free money.
6. Avoid paying the minimum due only.

Understanding Loans ( SECURED AND UNSECURED LOANS)

A loan is a form of debt incurred by an individual or other entity. The lender—usually a
corporation, financial institution, or government—advances a sum of money to the borrower. In
return, the borrower agrees to a certain set of terms including any finance charges, interest,
repayment date, and other conditions.

Components of a Loan
There are several important terms that determine the size of a loan and how quickly the borrower
can pay it back:
 Principal: This is the original amount of money that is being borrowed.
 Loan Term: The amount of time that the borrower has to repay the loan.
 Interest Rate: The rate at which the amount of money owed increases, usually expressed
in terms of an annual percentage rate (APR).
 Loan Payments: The amount of money that must be paid every month or week in order
to satisfy the terms of the loan. Based on the principal, loan term, and interest rate, this
can be determined from an amortization table.
Types of Loans
Loans come in many different forms. There are a number of factors that can differentiate the
costs associated with them along with their contractual terms.

Secured vs. Unsecured Loan

Loans can be secured or unsecured. Mortgages and car loans are secured loans, as they are both
backed or secured by collateral. In these cases, the collateral is the asset for which the loan is
taken out, so the collateral for a mortgage is the home, while the vehicle secures a car loan.
Borrowers may be required to put up other forms of collateral for other types of secured loans if
required.

Credit cards and signature loans are unsecured loans. This means they are not backed by any
collateral. Unsecured loans usually have higher interest rates than secured loans because the risk
of default is higher than secured loans. That's because the lender of a secured loan can repossess
the collateral if the borrower defaults. Rates tend to vary wildly on unsecured loans depending
on multiple factors, such as the borrower's credit history.

Revolving vs. Term Loan

Loans can also be described as revolving or term. A revolving loan can be spent, repaid, and
spent again, while a term loan refers to a loan paid off in equal monthly installments over a set
period. A credit card is an unsecured, revolving loan, while a home equity line of
credit (HELOC) is a secured, revolving loan. In contrast, a car loan is a secured, term loan, and
a signature loan is an unsecured, term loan.

Student Loans

A student loan is a type of loan issued to borrowers who need funds to pay for college. These
funds can be used for paying tuition fees and other related school expenses such as books and
educational material, thesis, gadgets and tools, allowances, accommodations, and living
expenses. Just like a regular loan, a student loan needs to be repaid on a regular/installment
basis with interest.

Student loans are special types dedicated to helping struggling students pay for their
undergraduate or postgraduate education. These loans are usually broad and cover tuition fees,
the cost of books and education supplies, allowances, living, and other school expenses. Student
loans are also called tuition loans or education loans. Student loans can be paid in installments
with pre-agreed interests like most other loans. Some agreements also allow students to pay
back the loan after they graduate.

Types of Student Loans Available in the Philippines

1. Government-sponsored student loans. The Philippine government offers several

student loan programs to support students in their pursuit of higher education. These
loans often come with lower interest rates and flexible repayment terms, making them a
viable option for many students.

2. Private student loans. Private financial institutions also offer student loans to cater to
students who may not qualify for government-sponsored programs. These loans may
come with varying interest rates and repayment plans.

3. Scholarships and grants. Apart from loans, students can explore scholarship
opportunities and grants to fund their education without the need for repayment.
Scholarships are usually merit-based, while grants may be need-based.

Next meeting, research on the examples of government-sponsored student loans. Discuss its
requirements to avail the loans, the interest rates and the terms and conditions.

Private vs. Government Student Loans

Pros and cons of private loans

Private student loans may offer more flexibility in terms of borrowing limits and repayment
options. However, they often come with higher interest rates and may not have the same
borrower protections as government loans.

Pros and cons of government loans

Government-sponsored student loans generally offer lower interest rates, more favorable
repayment terms, and additional borrower benefits. However, they may have stricter eligibility
criteria and borrowing limits.

In the Philippines, government agencies such as the Social Security System (SSS) and the
Government Service Insurance System (GSIS) offer student loans and financial aid programs to
eligible students. These programs aim to provide assistance to students who face financial
challenges in pursuing their education.

Student loans are a great way to finance your education and give you more options for the
future. They can help you pay for your tuition fees, tools, equipment and other living expenses.
They can also cover review expenses for professional licensure exams. It’s a win-win situation
for you and your family.
Taking out a student loan can be a helpful way to finance your education in the Philippines.
However, it is important to understand the terms and conditions of the loan before signing on
the dotted line. Be sure to consider the interest rates, repayment periods, and consequences of
defaulting before making a decision. By doing so, you can ensure that you are making a wise
financial decision for your future.

THE MOVE TOWARDS DEBT FREEDOM

Avalanche Effect. This method involves making minimum payments on all your outstanding
accounts and using any extra money to pay off the bill with the highest interest rate.

Debt Inventory. A debt inventory refers to a comprehensive list or record of all the debts a
person or business owes.

Snowball Effect. This method involves paying off the smallest debts first and then moving to
bigger ones.

References:
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Daly, L. (2024) How Credit Cards Work: A Beginner's Guide
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Kagan, J. (2024). What Is a Loan, How Does It Work, Types, and Tips on Getting One
https://www.investopedia.com/terms/l/loan.asp
Mill, A. (2020). Personal Finance From Saving and Investing to Taxes and Loans, an Essential
Primer on Personal Finance, p. 80-110
Smith, L. (2024). Debt Management Guide
https://www.investopedia.com/articles/pf/12/good-debt-bad-debt.asp
Tiongson, R. (2019). The No Nonsense Infographic Guide to Personal Finance, p. 30-41