Before assuming a credit responsibility, it is better that you analyze the options you have to avoid falling into debt; however, in this article, we leave you with certain characteristics of them, why they occur and everything you should take into account before contracting them.
What is the cost of debt?
The cost of debt is that cost that refers to the financing or credits that a company requests to carry out its development or activity.
How is the cost of debt calculated?
The cost of debt is the result of the sum of the interests of each of the debts contracted by a company.
For example: if a company contracted a loan for $250,000 with an interest rate of 4% and also has another debt of $1,000,000 with an interest rate of 5%.
The total interest cost would be the sum of $10,000 plus $50,000 which would give a result of $60,000.
What generates debt?
When an individual requests money from a bank, in this case, it is said that they are incurring a debt, an obligation that conforms to certain previously imposed conditions, that is, that the debtor must return the money that has been lent to him in a certain period of time in addition to paying the taxes that are attached to said loan.
What characteristics does a debt have?
The main characteristics of a debt are the following:
- It is a cost that can be observed
- It is easier to calculate
- Cost after tax value is used
What is the cost of short-term debt?
When a company or business is granted a short-term loan, these serve to appease deficits that only occur temporarily, in this way your cash flows will remain healthy until you achieve a balance or balance.
When this happens, banks offer financing taking into account your credit history to find proof of whether you can pay off the debt.
What is the cost of long-term debt?
If, for example, you are thinking of a house, surely you should request a mortgage loan, these types of loans are long-term and you must prove to the bank that you have the necessary solvency to face credit responsibility in an extended period of time.
With regard to the interests of the debts, both long and short term, you must consider all the characteristics of the credits since the attached interests depend on the time and the amount required and in this way, choose the one that suits you best.
How is interest on debts calculated?
When reference is made to interest, it is calculated as a percentage of the loan in relation to the remaining balance; Paying interest on a loan is paying for the privilege of using borrowed money.
Most commonly, an annual interest rate is applied, although there may be an interest rate that is awarded in a shorter period of time.
What are the lowest interest rates?
In general, the interests of short-term loans are lower than long-term loans; This is due to the fact that long-term credits are accompanied by an even higher interest and that the installments are extended over long periods of time, making it more likely that there are unforeseen events or that unpaid installments are generated.
What is the difference between long-term and short-term financing?
- Short-term loans are calculated from a bank prime rate.
- It is not possible to acquire a short-term loan to make a large or high-value purchase.
- The interest rate of a long-term financing is secured from a fixed term with repayment that extends over the same amount of time that the loan lasts. This works as a kind of guarantee before the financing request.
What are the types of debt that exist?
Debts are classified according to the issuer as:
- Public debt: this type of debt is the one acquired by a state in relation to both national and foreign investments.
- Private debt: debts of this nature are those contracted by both physical and legal persons and that do not correspond to the Public Administration.
- Regarding the granting of financing, the State is the one that offers a cheaper option since its solvency capacity and to cushion the impact is much greater.
- Then, we can find the option of interbank financing
- Another option is that of corporations whose intrinsic obligation is to pay the highest interest in relation to the normal condition of the markets. The longer the financing term, the greater the risk and the higher the interest requirement.
According to your credit quality:
The same company can issue different types of debt, in turn, this debt is assigned a certain score that is directly related to the risk assumed by whoever acquires that debt. This score awarded establishes a position in relation to other debt instruments issued by the same financial entity.
In the event of bankruptcy, there is a chance that the company will not be able to repay the investor, however, but if the opposite is the case, that is when a company's risk is calculated.
If in any instance the entity issuing the asset cannot comply with the contracted obligations, a priority order will be issued in the event of an imminent default.
Within the types of debt, you can also find different categories:
- Senior secured debt: this classification refers to the mortgage bonds that function as a backup when mortgage loans are carried out, which can only be issued by banks.
- Senior debt: they are what we know as obligations or bonds and may differ in their forms of payment, which is done by coupon or periodicity.
- Subordinated debt: this type of debt does not have a good reputation due to its poor quality; This is due to the collection of interest on which it depends on certain benefits imposed by the financial institution.
With this type of debt, the investor and the issuer depend on each other, because if it does not progress favorably, the investor does not either.
- Hybrid debt: In the event of a bankruptcy situation, this type of debt issued in the long term or with an indeterminate term, has the possibility of being canceled by the company on a pre-established date.
