Debt

Debt is a financial liability or obligation owed by one person, the debtor, to another, the creditor. 

Debt is mainly composed of two elements: principal and interest. While debt can take many forms, the main variables by which debt differ are: (1) the amount of principal; (2) the maturity, or the amount of time until the debt is due; (3) the interest rate; and (4) the frequency by which interest is accrued, i.e. how frequently it is calculated. For example, an individual could borrow $1,000 to be repaid in ten years, with 2% interest accruing semi-annually. Or, alternatively, an individual could borrow $1,000 to be repaid in five years with 5% interest accruing annually. 

The party taking on the debt may be referred to as the borrower or debtor. Individuals, corporations, and government bodies may hold debt. For example, corporations often issue corporate bonds to investors, becoming indebted to the investors, to fund new projects. Government bodies at the local, state, and federal level also issue bonds to investors, becoming indebted to them, to fund new projects or to cover budget deficits. Debt issued by local governments to fund projects such as infrastructure or schools is referred to as municipal bonds. Debt issued by the federal government is most commonly issued in the form of treasury bills, treasury notes, and treasury bonds. The aggregate total of the federal debt is referred to as the national debt. 

Debt may take the following forms: loans, bonds, promissory notes, debenture, mortgages, and amounts owed on a credit card, among others. A form of debt in the abstract may be referred to as a debt instrument. Debt can be distinguished as to whether it is secured, where the borrower pledges other property to guaranty the repayment of the debt, or unsecured, where the borrower does not pledge any other property to guaranty the repayment of the debt. Debt can also be distinguished as to whether it is recourse debt, where the lender may pursue the debtor’s personal assets, or nonrecourse debt, where the lender may not pursue the debtor’s personal assets to secure repayment. 

When an individual fails to repay their debt, the borrower, or creditor, may bring a legal action. Such actions will be governed by debtor and creditor law. For example, in a recent New York case, where a party failed to pay a $3,000,000 promissory note when due, the creditor brought an action in New York state court to collect on the debt. If a party is unable to satisfy their debts, and the parties do not otherwise reach an agreement, the debtor may file for bankruptcy. Even if the creditor obtains a judgment from a court confirming that the debtor owes them the debt, the collection of that debt will be regulated by the state’s Fair Debt Collection Practices Act. 

[Written by Blaine Fix of the Wex Definitions Team in September 2021]