Debt has become so common that many people think it’s inevitable in today’s world. In most countries, debt has become a huge problem facing individuals and businesses. And this problem worsens in periods of economic recession. Taking a debt might be necessary at times. For example, an individual might need to apply for a credit card in order to make some purchases and pay back over time. Similarly, a business owner might take up a loan in a bid to expand his or her business.
However, debt becomes a quicksand when unforeseen factors make it difficult for the debtor to pay back. And this is what happens in most cases that lead to foreclosures and declarations of bankruptcy.
Two types of debt exist: personal debt and business debt. While this classification might seem unnecessary, it makes a lot of financial sense because laws make distinctions between these two types of debt for the purposes of collections and bankruptcy. Now, let’s discuss the differences between personal debt and business debt.
What is Personal Debt?
Personal debt is debt that you are legally responsible for as an individual. Though the name might suggest a single individual, personal debt can actually involve more than one party. A good example is when you and your spouse take out a loan together for a home. In that sense, “personal” really just implies “non-business.” So, a debt incurred by both you and your spouse or your friend will be recognized as personal debt because it does not involve a business entity. Personal debt is used to fund consumption.
What is Business Debt?
A business debt, on the other hand, is debt that has been incurred by a company. The owner, directors, or employees of a business can incur debt on a company’s behalf. A company can only be held liable for a business debt if an individual who has the authority to authorize debts on the company’s behalf authorized the debt.
The director of a company or another authorized individual can only be personally held liable for the company’s debt if the individual signed a personal guarantee or incurred the debt knowing that company was insolvent. Business debt is used to fund investment.
Both personal and business debts can be secured or unsecured. Secured debt is debt acquired by putting up a valuable property belonging to the potential debtor as collateral. Unsecured debt relies solely on your credit history and your promise to pay.
Causes of Bad Business and Personal Debt
People incur personal debt due many reasons. Sometimes, it could be due to harsh unforeseen circumstances, such as job loss and ill health requiring huge medical costs. It could also be due to individuals’ pay rates not being enough to cover their costs of living, even when they work full time or combine jobs.
Some people are well paid and they are not losing money to unexpected expenses, yet they acquire debt. Such people lack the financial discipline required to stick to a budget or simply don’t understand the true difference between wants and needs (so they pay for everything altogether). Businesses, too, incur debt through a number of ways.
Poor conditions in the overall economy and specific market in which a business operates might lead to debt acquisition. Lack of planning and levelheaded thinking can lead to hasty decisions and business failures stemming from huge debts. Other common causes of business debt include poor business locations, loss of key employees, lawsuits raised by competitors or aggrieved customers, personal issued such as illness and divorce, and unforeseen disasters and criminal activity, such as floods, storms, theft, and fraud.
Consequences of Bad Business and Personal Debt
Personal debt decreases the amount of your disposable income. And if you fail to pay back on time, your credit score gets slashed, making it difficult for you to secure personal loans in the future. Personal debt can also greatly reduce what you will leave for your surviving ones when you are no more (you can even leave them in huge debt). Business debt causes hardship and eventually leads to bankruptcy.
How to Eliminate Bad Business and Personal Debts
The best way to eliminate personal debt is to come up with a realistic budget and track your expenses. It is advisable to start with debts that have the highest interest rates, dedicating as much as you can afford to debt repayment. Alternatively, you can use debt consolidation, refinancing, negotiation, or settlement to get a fresh start or reduce your debt to a lower level that you can manage easily.
For business debt, increasing business income and reducing expenditures to the barest minimum is best. However, options such as debt consolidation, negotiation, and bankruptcy also exist.