What is Debt? Meaning, Definition and Examples of Debt

Meaning of debt

Before we begin to comprehend the meaning of debt, first let's briefly discuss its etymology (i.e. origin or history of words).

The English word debt has its origin in Latin word debitum, which means to owe something to someone.

Here, in context of above sentence:

1. Something can be money, articles, promissory note, etc.
2. Someone is used to refer to an individual or entity that does the activity of lending (giving).

The following image depicts this origin of English word debt.

So, what is debt? Let's understand its meaning:

• Debt is a current obligation or due at present on a debtor. It is supposed to be settled or repaid in the future.
• Debt settlement is a way to keep up or fulfill borrower's (debtor's) promise of repayment made to the lender (creditor).

The concept of debt is not that of modern times rather it is very old. It has its roots deepened in the ancient past. It is known to have emerged when people just started to engage themselves in various barter-related trades. It was also functional at the advent of world's oldest known human civilization established in Sumeria.

Sumeria is an old name of what is called ancient world's Mesopotamia or today's Iraq.

David Graeber, authored a book titled, Debt: The First 5,000 Years. In this 2011 published work, he has traced the historical development of the idea of debt. According to him, debt-systems were, firstly, recorded in Sumerian civilization around 3500 BC.

Fifteen points listed below broadly explain the conceptual meaning of debt:

1. Debt is an arrangement of finance made by lender and is given to the needy and eligible borrower.
2. It is a total amount (sum) of money borrowed by a debtor from the lender.
3. It is a financial commitment made by a borrower to the lender who has provided the necessary funds (money).
4. Its transaction is usually done in form of cash or through bank's payment.
5. Its disbursement (paying out) is done in borrower's domestic currency.
6. Generally, here, two parties are involved in a financial transaction. They are commonly known as a debtor (borrower) and creditor (lender).
7. Debtor is either an individual or entity that borrows money or owes to pay money to the lender.
8. In context of finance, a debtor is also known as the borrower.
9. Creditor is either an individual or entity that lends or gives money or owes to receive money from the debtor.
10. In financial perspective, a creditor is also known as the lender.
11. Debtor or creditor can be either an individual or entities such as firms, companies, banks, associations, governments and other financial or non-financial institutions.
12. The amount of money given as debt is usually based on the market value of the asset or regular cash inflows (e.g. from salary, rent, so on) owned by an individual or entity that applies for it.
13. It always carries an additional financial obligation, which is known as interest. In short, it carries an interest.
14. Interest paid on it (borrowed-money) is treated as an expense. In ascertaining of profits of business, interest paid on it is treated as a deductible expense against income generated from business operations.
15. Basic or fundamental components of it are listed below:
    • Amount of principal repayment,
    • Rate of interest charged,
    • Schedule of repayment, and
    • Terms and conditions for its settlement.

With this understanding, now let's proceed further and define debt.

Definition of debt

Though debt is a simple concept to understand and figure out; it may not be easy to state its perfect definition. This is because it is defined by various groups of people in different ways.

Following image depicts the definition of debt in different contexts.

The perspectives or aspects under which a debt can be defined are:

1. General,
2. Finance,
3. Academic,
4. Business and
5. Banking.

Now here are five definitions of debt w.r.t. above viewpoints.

1. General : Debt is an ascertained (predetermined) sum of money which a debtor agrees to pay to its lender.
2. Finance : Debt is usually scheduled with a series of regular cash outflows (installments) to repay its principal amount along with interest by a borrower to the lender.
3. Academic : Debt is formed when two parties (debtor and creditor) agree under an express (written) or implied (verbal) agreement to borrow and lend money.
4. Business : Debt is a source of finance (money) required to run a business and a part of corporate strategy. It helps to generate excess returns (income) from business activities, which ultimately, aids in its repayment.
5. Banking : Debt is an amount of money borrowed by an entrepreneur (businessman) from various financial institutions to overcome his long-term and short-term financial requirement.

Examples of debt

Here are some common examples of debt depicted and listed below.

Following is its list:

1. Commercial papers,
2. Bonds,
3. Home loan,
4. Car loan,
5. Term loan,
6. Personal loan, so on.

Now let's discuss above-mentioned examples one by one.

Common debt examples based on their popularity and tenure:

1. Commercial papers are short-term sources of debt. These are used to acquire funds from the market and are usually borrowed for 14 to 365 days.
2. Bonds are paper-based debts. These are used to acquire funds from market and other financial institutions. These expire after 5 to 10 years.
3. Home loan is a type of debt taken to buy a house. It is used to purchase tangible residential assets or properties. It is to be repaid within next 5 to 20 years.
4. Car loan is a debt taken for buying automobiles. It is used to purchase tangible movable assets like cars. It is usually to be settled within one to five years.
5. Term loan is another debt taken for a specific period. It is used by the entrepreneurs to overcome their business-related financial requirements. Generally, it is borrowed for more than one year.
6. Personal loan is also a debt taken to meet requirements of life. It is borrowed by individuals to finance their personal-requirements like marriage, renovation of a house, etc.