Debt Obligation Definition

According to LawInsider, the phrase debt obligation s really just a repetitive way of saying either debt or financial obligation. When you borrow money from any source, whether it's a bank, a family member or a payday advance, you owe a debt to the person or entity from which you borrowed the money, and that debt is your obligation. The words "debt" and "financial obligation" can be used interchangeably, and they describe the same thing – money you owe to someone else.

Generally speaking, a debt obligation can be defined as any sum of money that is owed to a person or institution as part of an earlier exchange for goods or services.

Debts are typically incurred when you need money for something, and you borrow the money to make the purchase. This is true whether you're buying something large, like a car or a house, or simply buying a series of smaller items such as when you use a credit card to pay for groceries, clothing or trips to the movies.

You may borrow the money to help pay your living expenses during school or you have a cash flow problem during a personal financial crisis, causing you to resort to expensive payday loans. Either way, when you incur any type of debt from a financial institution like a bank, you enter into a contract in which the lender promises to loan you money, and in return, you promise to pay it back, usually with interest. Loan contracts are usually in writing and signed by the borrower.

There are several categories of debt that are common including residential mortgages, car loans, student loans, medical bills and credit card debt.

Some of these debts are collateralized debt obligations, also known as CDOs. This means that in exchange for the money, you agreed to repay it, but you also gave the lender collateral for the loan. Collateral is property that you offer to the lender as security for the loan obligation. If you end up not repaying the loan as required, the lender can take the collateral to satisfy the debt.

MyCreditUnion.gov explains that the most common types of secured debts for individuals are auto loans and home mortgage loans. When you take out a bank loan to buy a house, a car or other real estate, the bank will put a lien on the property you're purchasing, and if you don't repay, the bank will repossess or foreclose on the property. Ultimately, they may resell the property to recover the money they loaned you. Lenders may offer lower interest rates since the collateral reduces their credit risk.

Other debts – like medical and utility bills, most credit cards and student loans – are unsecured debts. Unlike a secured debt, which is guaranteed by some sort of collateral, unsecured debts are not secured by an asset. Because there is no collateral collected from you to protect the lender, the only thing the lender gets in return for giving you the money is your promise to repay the obligation. For this reason, unsecured debt typically has a higher interest rate than secured debt.

Interest rates on loans are determined by several factors. In general, secured loans with collateral will have lower rates than unsecured loans. However, rates are also influenced by the borrower’s credit rating and the quality of the collateral.

For example, borrowers with lower credit ratings can still get home mortgages, known as subprime mortgages, but they will pay higher interest rates. In this case, lenders will perceive that they have a higher risk of default and will charge higher rates to offset the increased risk.

Interest rates are also affected by the interest rates in the general market. Vendors usually bundle all of their loans together, known as securitization, and sell the loans in packages, called tranches, to institutional investors, such as insurance companies, pension funds and hedge funds, to improve their liquidity to make more loans. Interest rates on asset-backed securities, collateralized loan obligations and mortgage-backed securities will typically be lower than interest rates on bundles of unsecured loans, but they will have to be high enough to attract investors.