Now that you’ve learned who the players are in the debt game, we’re going to discuss types of debt. Fundamentally, there are two types of debt: secured and unsecured.

The type of debt you “play” with in the debt game may depend on a variety of factors such as your credit rating, the type of product you’re trying to purchase with debt, and regulatory limitations.

When a person or institution loans us money, they want to know when they will get their money back, how much they will be paid for their faith in us that they will get it back, and what will happen if we don’t pay it back. If a debt is secured by something, the lender expects that if we don’t hold up our end of the agreement, they can go to the security or collateral on the agreement and collect what is owed them.

If a debt is secured, it means you, as the borrower, will only receive the loan if you can offer collateral of some type to the borrower. In essence, if the lender expects either you (based on your credit history) or the loan to be risky, the lender will request collateral, or something with a value equal to the amount you are borrowing. The lender requires this to ensure that if you don’t hold up your end of the agreement, the company can collect on the loan by using the collateral to recoup what is owed.

What exactly is collateral? Collateral is something of value that we already own that can be used as a guarantee that a borrower will pay back that loan. Collateral can range from a car, boat, jewelry, or a house, depending on the size of the loan.

Similarly, if we rent a home, the landlord often takes a month’s rent in advance, the final month’s rent, and a security deposit at the time you sign the rental agreement. The money you give the landlord secures your lease agreement that you will, in fact, move in when you said you would, you will not leave without paying your last month’s rent, and you will leave the home in the condition you found it when you moved in.

Students often cannot come up with that much money up front. They may ask their parents to cosign on the lease, making the parents liable to the security on the rental agreement. That way, the landlord has recourse through either of the cosigners to get the money owed according to the rental agreement.

When you borrow money to buy a home, the mortgage lender will probably require you to put money toward the house as a down payment. The lender doesn’t want 100% of its money in the home in case it loses value before the loan is paid. The lender holds the title of ownership for the house until you pay it off.

Co-signing on a loan is, in a sense, a form of secured lending. Agreeing to be a co-signer on someone else’s loan can be a gracious thing to do for a friend or relative, but remember that business is business. Before you agree to put your signature on the agreement, be sure that you have read the terms and conditions of the contract and know what you are about to sign for. Although the borrower assures you that her plans are good and that she has no intention of not paying back her loan, “debt happens” and you may be the one ending up paying off the loan.

One of my clients was a 55-year-old widow who had most of her savings in a 401(k) tax-deferred retirement savings plan and an IRA that had been left to her by her husband. Her son decided to go into the carpet cleaning business and needed money to buy the franchise, a van and the cleaning equipment. He was confident that this was going to be a booming business, and he had dreams of a fleet of vans and a number of employees. He had dropped out of college and had only a few hundred dollars in savings to start his business.

His mother was pleased with his entrepreneurial spirit and agreed to co-sign his loan with the bank to start the business. Because her savings were all in tax-deferred retirement accounts, she became liable for the taxes at her current interest rate of 28 percent and a 10 percent penalty because she was not yet 59Yz. Even though the money was still in her savings accounts, she triggered these IRS events when she agreed to use them for collateral on her son’s loan.

Unfortunately, after a year in the business, her son had developed an allergy to the cleaning chemicals and had to abandon his business. Guess who got stuck with the loan payments! Mother will now have to work much longer than she had planned.

I love my kids, but I don’t think we as parents owe them as much as we often think we do in terms of financial help. We love and care for them as parents. We may help them to get started in a business or a career if we can afford to and choose to without guilt or obligation. But we are not required to jeopardize our own well-being or retirement to help our adult children financially.

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