Debt, in its simplest form, is a financial obligation where a borrower owes money to a lender. There are different types of debt. The most common types of debt are mortgages, auto loans, student loans, credit cards, and personal loans. Some debts, such as a mortgage and potentially an auto loan, are inevitable, whereas student loans, credit cards, and personal loans are avoidable. 

Debt in Three Components

While there are all types of debt, all deals comprise the same three components: principal, interest, and repayment terms. Lenders (banks) will typically try to sell you debt based on the monthly payment. This technique is used to lend you more money than you need or charge you higher interest masked by seemingly manageable payment amounts. 

What role does the federal RESERVE play in debt?

The Federal Reserve, often referred to as the Fed, is the central banking system of the United States. It is an independent government agency responsible for conducting monetary policy, regulating and supervising banks, and maintaining stability in the financial system. The Fed loans money to banks and controls the supply and demand of the US Dollar. The Fed has played a significant role in combating post-COVID inflation. 

During much of the COVID-19 pandemic, the Fed reduced interest rates to near zero. This meant that banks and other institutions could borrow money at a meager cost. The purpose of this was to help stimulate the economy during the pandemic. Unfortunately, this helped contribute to inflation rising faster (5.4%) than usual (2-3%). Inflation is a normal function of our economy, but when the rate of inflation happens at a higher rate than usual, it can have negative impacts and must be counteracted.  A way to slow down the inflation rate is to reduce the money supply on the market. This is done by increasing interest rates which makes borrowing money more expensive, reducing demand and reaching market equilibrium. 

When the Fed adjusts interest rates, it often influences banks and financial institutions to follow suit, affecting the terms of credit cards, auto loans, and mortgages.  Knowing what the Federal Reserve is doing is critical to making informed financial decisions. 

Why does my credit score matter?

Your credit score reflects your financial reliability and creditworthiness, which is crucial for various aspects of your life. As a Service Member, it can influence your Security Clearance and job opportunities. Additionally, a higher credit score enables you to secure better interest rates on mortgages and auto loans, offering significant cost savings compared to lower credit scores. Maintaining a good credit score is essential for maximizing financial opportunities and minimizing borrowing costs.

How does debt impact my credit score?

The amount of debt you owe lenders compared to your available credit, known as your credit utilization ratio, plays a crucial role in your credit score. Higher debt levels relative to your credit limits can lower your credit score. Additionally, late or missed payments on your debt can hurt your credit score. You should be committed to becoming debt-free and relying less on borrowing, as it allows you to achieve financial independence and reduce financial stress. However, it is crucial to understand that maintaining a good credit score is still valuable as it helps secure certain services like renting a home or obtaining insurance. Balancing the goal of debt freedom with the need to maintain a healthy credit score ensures a solid financial foundation for the future.