What is debt?

Read time:

5–7 minutes

First things first:

Debt is the amount of money you owe. If can come in lots of forms – credit card debt, student loan debt, a mortgage, or a car loan, just to name a few.

If you’d like to learn about Credit Cards or Credit Card Interest before jumping into this topic, check out those articles here:

Finance Foundations

Let’s walk through an example of what debt is and how people can get into debt. Learning through examples will help us apply the knowledge we learn, so let’s look at the story of Shawteigh and her debt.

Recently, Shawteigh has been down on her luck. She currently has $1 to her name, which is rough, but even worse, she wants a coffee and cannot afford one. $1 can really only buy her the tiniest, nastiest gas station coffee, which is not what she wants. Shawteigh quite likes the caramel craze frappucino from starbies, and quite frankly, she will accept nothing less. It’s Monday – she can’t go without her coffee! Desperate, she goes to her friend Huxley.

Luckily, Huxley has a $5 bill and is happily willing to loan it to Shawteigh – on one condition. She has to pay him back by the end of the school week. Naturally, she agrees and goes to buy her frappucino. With her $1 and Huxley’s $5, she buys the $6 coffee. She drinks it in 83 seconds and is now much, much happier.

However, she is also now in debt! Let’s look at 2 scenarios. You can choose whichever one you want to start with: the happy or sad one.

Happy ending:

Shawteigh is unemployed, but she has a good idea! She heads over to Aldi after school and offers to return peoples’ carts for their 25¢. After a little while, she makes $6 in quarters and then goes home.

The next day at school, Shawteigh sees Huxley and hands him $5 in quarters. As a way to say thank you for letter her borrow the $5, she also pays him an extra 25¢. Huxley is glad to have the $5.25 and tells Shawteigh she can borrow from him any time.

Hooray! She paid his $5 back early and even paid him some interest! But what if she didn’t?

Sad ending:

Shawteigh goes home afterschool and watches Barbie Life in the Dreamhouse for the rest of the evening. She goes to sleep, and the next day at school, she runs into Huxley. He asks if she has the $5 to pay back yet. Yikes! Shawteigh tells him she doesn’t have his $5 yet, but she’ll get it to him by the end of the week like he asked. He says that’s totally fine, and they walk to class.

Later that day, Shawteigh starts really craving another coffee. After class, she asks Huxley if she can borrow $6 to get a coffee. He seems wary, but Venmos her $6 and Shawteigh gets her coffee again.

That night, she goes back to her house and watches Barbie Life in the Dreamhouse all evening again.

This happens the next night, the following night, and the night after that. And each day she asks Huxley to let her borrow $6 for coffee. Now it’s the end of the week, and look what’s happened.

$5 + $6 + $6 + $6 + $6 = $29

At the end of the week, she now owns Huxley $29… and she has $1 less than she had on Monday. With $0 to her name and all of the money she owes Huxley for coffee, Shawteigh has -$29. That means on Monday she had $1 and now, on Friday, she is $29 in debt. She’s in the negative!

There’s one other piece to this – Huxley doesn’t trust her any more! This example unfortunately has a sad ending 😦

Debt can be a great thing, because it can help us get things we need or want and then pay for them over time. Paying for college is super expensive, but with student loans, you can get your education and then pay for it afterwards when you have a real job with real income! Buying a house outright is extremely difficult – who has hundreds of thousands of dollars just laying around? – but with a mortgage, you can buy a home and live in it for years and years while paying for a little bit of it each month!

On the other hand, debt can also be a bad thing. If you have the tendency to forget to pay people back, you can end up owing a lot of money. You can also get into a lot of debt by buying a lot of things with credit (that means using someone else’s money) instead of with your own money.

Plus, when you buy something with credit, a lot of times whoever let you borrow their money will charge you interest. Remember in the happy ending how Shawteigh paid Huxley the extra 25¢? Well a lot of people will force you to pay extra! Learn more about interest here.

All of these factors can contribute to the snowball effect. Borrowing a little bit of money to pay your water bill one month may be harmless enough, but if you pay for rent with credit, buy a car on credit, and go back to college and take on student loans, you’re in a ton of debt! The debt starts as a little snowball and rolls and rolls until it’s an avalanche.

Some best practices when borrowing money are:

Don’t get into more debt than you have to
- Taking out a business loan to start a business = good debt decision!
- Buying $3,000 worth of designer shoes = probably a bad debt decision
Pay debt back on time – every time
Prioritize paying down debt over frivolous purchases
- Pay your credit card off before you go out and spend more money
  - (I am NOT saying “you have to stop buying coffee to be financially free!” or “you should never buy anything fun if you have debt!”. The people that say that are not giving helpful advice. Buy things you need, and even some things you want! I’m just saying you should prioritize paying down debt as much as you can if you want to work towards building wealth)
If you find yourself in an avalanche of debt – don’t worry. People pay off debt and become financially free every day. Take it one step at a time and get help (it doesn’t have to be a financial advisor, it could be Youtube videos, books, or a podcast!). It’s not impossible to pay off debt, but it does take dedication.