Toxic Debt

Toxic debt summary: 

• Any loan that can’t be repaid or that has excessively high fees and interest costs could be considered toxic debt.

• Common types of toxic debt include payday loans, car title loans, and predatory lending.

• If you have toxic debt in your life, you might want to try debt consolidation loans or debt settlement to get rid of it for good. 

Toxic Debt Definition and Meaning

Toxic debt is an unofficial term for types of debt that are highly unlikely to be repaid, making life worse for borrowers and lenders. If you borrow money with certain kinds of high-interest debt, you might be at risk for toxic debt in your personal finances. Toxic debt is also bad for lenders, creditors, and investors, because the debt is extremely risky and tends to not get repaid.  

The phrases “toxic debt” and “toxic assets” arose from the 2008 Great Financial Crisis, when subprime home mortgage loans got packaged into complicated bond funds which were then sold to investors—and often failed. When homeowners with less-than-fair credit couldn’t pay their mortgages, their mortgages went into foreclosure. And investment funds made up of thousands of these unpaid mortgages then became “toxic assets” based on “toxic debt.” 

If you’re struggling to pay your bills and falling behind on credit cards, these overdue debts could become “toxic debt” in your own life. But the good news is that even if you have unpaid debts, you have choices, and there’s hope for the future. You could have several options to get rid of toxic debt, including debt consolidation loans or debt settlement programs.  

Key Features of Toxic Debt 

Not every debt becomes a toxic debt, but some forms of debt are riskier than others. Here are a few key features of toxic debt: 

• High interest rates and fees: Toxic debts tend to have higher interest rates or APRs that make the money more expensive to borrow. Credit card debt is known for its high interest rates, but payday loans and car title loans can have even worse APRs when you add up the fees. 

• Marketed to people with low credit scores: If you can't qualify for other credit, you may be more tempted to take on toxic debt. But toxic debt isn't easy to get rid of; if you use payday loans, for example, that expensive debt could land you in a debt cycle that's hard to escape.

• Delinquency: Toxic debt you can't afford could mean you fall behind. If you stop making payments, you'll typically have your debt declared delinquent. Delinquent debts could be sent to collection agencies and hurt your credit scores.

• Everyone loses: In an ideal situation, lenders and borrowers may both benefit from debt. The borrower gets the funds they need, and the lender makes money as the loan gets repaid with interest. But toxic debt is a lose-lose situation that hurts you and costs your lender money.

Types of Toxic Debt 

Most types of everyday debt—like mortgages, auto loans, and credit card balances—aren't inherently toxic (though they can turn toxic if the terms are bad or you can't make payments). However, there are a few types of emergency loans and other debt that many consider toxic by nature: 

• Payday loans: Payday loans tend to charge some of the highest fees of any type of debt, even as high as 400% to 500% APR. These loans could easily become debt traps, in which people end up paying fees to keep borrowing the same money over and over again without ever getting out of debt.  

• Car title loans: Some states allow lenders to offer car title loans. With these loans, people use their car as collateral to borrow money with very high fees, sometimes up to 300% APR. This toxic debt could be hard to keep up with, but if you fail to repay the loan, you could lose your car. 

• Predatory loans: Payday loans and car title loans are two types of toxic debts that are often considered predatory lending, because lenders prey upon financially desperate people. But there are other types of predatory lending. Some lenders that offer financing for rent-to-own furniture and appliances have been accused of predatory lending for charging high fees or using abusive practices. Other lenders might also practice predatory lending by pressuring people to take out higher-interest loans that are full of extra fees. 

Borrowing money should ultimately be a fair deal that helps you improve your financial life. But unscrupulous lenders who take advantage of people’s financial needs mean you could end up with toxic debt instead.