Debt, mortgage and collateral: Decoding the jargons

The Evergrande fiasco has brought back the focus on debt, a term that motivates as well as scares people.

The Chinese property developer, hit by a severe liquidity crunch, sits on a pile of debt worth US$305 billion – 2.1% of the country’s total gross domestic product (GDP).

The embattled group has seen its cash reserves plummet due to a slowdown in the Chinese property market – triggered by a crash in property prices as well as lack of funding avenues after state-owned lenders in China cut off their credit lines.

Decoding the jargons Debt mortgage and collateral

 

At a time when there has been more than enough liquidity available in the system, the Evergrande saga has shone a glaring spotlight on companies’ debt.

So, what is debt?

Debt usually refers to a sum of money borrowed by one party from another. The debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. It is used by a company or an individual in case they want to they want to make a large ticket purchase, otherwise unaffordable by them. This money, along with interest, is paid back in small portions.

What are the various kinds of debt?

There can be two types of debt – one lent to individuals and one lent to companies. While individual debt is only in the form of loans, there is a gamut of debt products for companies. The debt products for companies include loans, bonds, commercial paper and debentures, among others. The debt can be of secured as well as unsecured nature. The secured debt is the one which has an underlying collateral, while an unsecured debt doesn’t have any underlying collateral.

What is a collateral?

A collateral is an asset that a lender of loan accepts as security for the money lent. This may take the form of real estate or other kinds of assets, depending on the purpose of the loan. The collateral acts as a guarantee of repayment for the lender. In case the borrower defaults on their loan payments, the lender can seize the collateral and sell it to pare some or all of his losses.

What is a mortgage?

A mortgage is a loan that's used to finance property – home, land, or other types of real estate.  The property, for which the loan has been taken, acts as a collateral in this case. Mortgage loan applications usually go through a rigorous underwriting process before loans are lent out. The types of mortgage vary based on requirements of the borrower, such as conventional and fixed-rate loans.

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