You may have heard or read material from financial experts about the dangers of debt. However, hopefully, you have also heard that not all debt is the same. Many people are told from an early age that student debt is considered "good" while credit card debt is considered "bad." It turns out that understanding debt is much more complex than even good and bad types of debt. There is also something called nonfinancial debt, and you should know what it is, how you can use it as a financing option and what to do to protect yourself from risk.
What Is Nonfinancial Debt?
Nonfinancial debt does not mean debt that doesn't involve money. On the contrary, it does involve money. Nonfinancial debt is debt issued by nonfinancial institutions, such as the government, a household or a business not engaged in the financial sector.
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The nonfinancial sector is a term that encompasses a vast array of businesses. Legally defined, they are independent from any involvement in the financial industry. These entities can be corporations, small businesses, manufacturers, and many other types of companies.
Some examples of nonfinancial debt might include someone who buys a car from a friend when the two agree to a payment plan, just between the two of them. Whether or not they sign a contract, it's still considered nonfinancial debt because the friend is not a financial institution. Some traditional debt is also considered nonfinancial. Credit card debt qualifies as nonfinancial because the issuer is nonfinancial (in most cases). Treasury bills are also regarded as nonfinancial debt.
Nonfinancial Debt Financing
Nonfinancial debt falls into one of four types of debt financing. The first of these is secured, named such because this type of debt is secured by collateral, explain the writers for Capital One. For example, a home mortgage loan is a secured debt because the house is the collateral. If you don't pay your mortgage, the bank will repossess your home. However, housing loans are also surprisingly sometimes considered nonfinancial debt.
Some credit card debt is unsecured, as are student loans (private and public). The lending institution trusts you to pay your balance back over time. Usually, credit scores determine your eligibility for unsecured debt.
There is also revolving debt. Most credit card debt is revolving. You charge and pay accordingly, but the balance may or may not reach 0, and the amount due will change. Finally, there are installment loans. These loans have a specific beginning and end date and are usually granted for a particular item, such as a car.
What Is Non-Debt Financing?
Non-debt financing usually refers to money that you're not expected to repay. These funds are generally not called loans, but grants, endowments, contributions, subsidies, gifts, allowances or even handouts.
Non-debt financing is usually issued for a specific purpose. For example, if a university wants to build a new library, it may solicit donations to fund it. None of the donors expect that the university will pay back the money. In exchange, though, they may want some recognition.
Most scholarships are also non-debt financing. You're using them to finance your education, and you don't need to repay those scholarships, unlike loans. Individuals can receive non-debt financing up to a certain amount from another individual before it is taxed and considered income. This amount varies for the federal government (around $14,000 per person) and state governments. Sometimes, parents sidestep this rule by setting up a trust for their kids or even opening a credit card in both of their names and paying the bill.
Consider also: Rated Debt vs. Unrated Debt