Obligation to Repay Explained – Everything You Need to Know

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Obligation to Repay Explained
Common in both business industries and personal lives, the obligation to repay is a concept that most people try to stick to, yet many of them fail, leading to even more losses in the long run. The obligation to repay is practically included in almost every agreement that involves lending money.

The legal profile of this concept is more common when dealing with actual institutions, such as banks or lending companies. But then, the obligation to repay can sometimes be unwritten, too – when you lend money from friends and family. The difference is there is nothing they can do legally if you fail to repay.

Now, the business obligation to repay goes further and includes a wide variety of aspects. For example, all advances will come with an obligation to repay. The same rule applies to any type of debt, not to mention liabilities.

The list is longer than that and may also include covenants or duties. All these things will normally arise under loan documents. They are usually defined in credit agreements, and they are given under a plethora of terms and conditions.

Then, all these obligations are owed by the guarantor to the lender. Administrative agents may also be included in such arrangements, not to mention indemnified people. Everything goes under the credit agreement and can be direct or indirect.

To keep things simple, the obligation to repay is your responsibility to check and meet all the terms and conditions in your agreement or contract. Those who fail to respect the obligation will injure the other party, which usually has legal ways to recover the debt – or at least try.

In other words, an obligation is a responsibility. It is most commonly given in a contract. Imagine your mortgage, for example – it comes with an agreement. The same rule applies to an automotive loan or perhaps a business loan.

On a personal level, failing to meet such obligations will bring in punishment. You are likely to end up with fees and fines, which will increase the debt. You can also face imprisonment, especially if the action was premeditated. In some cases, institutions or the legal system can confiscate goods – such as your home.

Obviously, the obligation to repay is a bit different for businesses, but the concept is pretty much the same. To make sure they can meet their obligations, businesses are often checked by lenders – debt, current liquidity, and even solvency ratios.

Becoming familiar with the concept of obligation to repay​

It may sound surprising for some, but obligations define today’s society and economy. Unless you are a 10-year-old kid and you live with your parents, chances are you do have some sort of obligations to deal with – be it for your studies, home, car, or just personal needs.

All these obligations are often met with detailed contracts that cover all the legal aspects. The belief that a contract will be respected is the aspect that makes a society thrive in a stable environment. Some may say that obligations represent the backbone of the economy.

Everyone must meet their obligations and fulfill them, or they risk punishment in one form or another. By everyone, it means people who get money from banks, businesses, companies, banks, governments, and all sorts of institutions must adhere to the contracts they have signed.

The obligation to repay is mostly defined in the financial industry. Such an obligation targets all the debt a party needs to deal with. Debt can come in more forms – most commonly, it is handled with regular monthly payments.

Do you owe money to anyone? Be it a bank or a close friend, this is a financial obligation for you. You have an obligation to repay. Pretty much any type of payment is an obligation. However, obligations can be fulfilled in different ways, depending on the agreement.

Most commonly, the obligation to repay refers to money. However, shares or stock and bonds may also be included. Such things can also count as obligations if they are included in your contract – of course, the situation varies from one company or individual to another.

Some obligations are more informal than others. If you get money from a friend or a family member, failing to pay will not really draw legal action, but it can ruin personal relationships. On the other hand, student loans or mortgages will most likely draw legal punishment.

Money is normally seen as a financial obligation. It is covered by the actual government. Practically, vendors and producers are meant to provide products or services in exchange for money – banknotes, and coins.

The connection between personal finance and the obligation to repay​

To most people, obligations represent the most significant part in personal finance. Most people try to handle their obligations before figuring out what they have left at the end of the month. In other words, you will pay your rent or mortgage first, then go on with other bills. You spend whatever is left.

If you do budget or write everything down, make sure you include every obligation to repay, especially if you are responsible for it and over a specific time frame. For instance, bills come with a time frame – a week or perhaps until the next one comes.

Obligations must be considered in a very careful manner because failing to repay could get you in trouble. However, such obligations go further than that and may affect you decades from now too – take retirement planning, for instance, which requires special attention from an early age.

Unexpected situations can always arise. Whether you plan for your little one’s college fund or your retirement, you need to think about obligations in the long run too. For example, have you thought about the interest on your mortgage? How about potential healthcare costs that may occur as you get older?

Based on where you live, there are different agencies that may provide useful data for guidance – if not sure how deep to go with your obligations. In the USA, for example, you have the financial obligation ratio released by the Federal Reserve Board – a handy benchmark for budgeting.

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Household Financial Obligations as a Percent of Disposable Personal Income​

Obligations and rights – Where is the catch?​

Obligations have multiple meanings, and each industry has its own definition. For example, the industry of derivatives explains obligations in different ways – especially when you think about options trading and what you can do there.

Take the call option, for example. It gives you an option – or better said, a right, but not an obligation. It can be defined as a financial contract. You gain a right through this contract – you can buy something, such as a commodity, a bond, or a stock, not to mention other instruments.

You have the right to buy an asset at a particular price, but only for a specific time frame. However, this is not an obligation. You have the option to do what you want – you can invoke this right if you find it profitable, but you are not forced to do it.

Options trading is definitely not for everyone. Just like any other type of trading, it comes with some sophisticated rules and requires lots of training and education. Many newbies often believe that purchasing an option implies buying some stock at a specified price.

It looks like it, but this is not the actual definition of a call option. Instead, you are purchasing a stock that will provide access to more stock for smaller prices. This is called the premium and represents one of the most attractive parts of buying call options.

While similar, the forward contract is quite different. The same goes for futures. Such a contract is not just about a right, but both about a right and an obligation. Simply put, you have the right and obligation to provide or take the respective asset.

Now, the obligation to repay is clearly about repaying something – money, most likely. However, an actual obligation is not necessarily financial. For instance, those who get elected as politicians have an obligation to represent the people who voted for them.

Different types of obligations explained​

Obligations are not always legal, meaning they cannot always be enforced. A legal obligation comes with a contract or an agreement – that is a completely different story. But if you borrow money from a friend without any papers, that is a moral obligation only.

Now, failing to meet legal obligations will most likely lead to punishment. The degree of punishment depends on the contract. You could end up with a poor credit score or maybe with debt collectors trying to take your car away.

This issue is more common in secured loans. Get a loan to buy a car, fail to make the payments, and chances are the auto company will come back at you to take the car back. The same rule applies to a mortgage.

Then, there are unsecured loans too. Debt collectors can still knock on your door, but there is not much else they can do. If they do take you to court, you risk losing valuables or face different restrictions to force you to pay the debt.

Most people associate the obligation to repay with loans – be it a mortgage, a personal needs loan, or a payday loan. However, obligations can sometimes go in more directions – even the obligation to repay could come without actually having a loan.

Take taxes, for example. Sure, there are communities out there where you might live without paying taxes. Some countries do not take an income tax, for instance. But then, you will indirectly pay taxes for the food you buy, in one way or another.

Taxes, therefore, represent a form of obligation. Failing to meet this obligation can bring in a plethora of fines and extra fees. Then, in some countries, you even risk facing imprisonment, especially if taxes are avoided on purpose – tax evasion.

Large companies in most countries have the option to declare themselves bankrupt. Declaring bankruptcy comes with consequences, though. You are losing everything, and creditors can still get some of their money back by selling assets companies still own.

However, this move relieves the debt for the debtor.​

In some countries, people are also allowed to file for bankruptcy. The same rule applies – you risk losing valuables. You will get creditors off your back too, but at least you have the option to start fresh. The credit score will be severely affected, and no one will give you any money at all.

The good news is starting from scratch allows you to do things right. You have messed up, and you have learned a lesson. Pay bills on time and build your credit score again – it may take years, but you will get back on track at some point.

The obligation to repay is not just held by a person. In fact, companies often find themselves in the exact same situation – take business loans for example, whether they require new equipment, money for expansion, or just capital to start.

Any type of contract that involves this obligation with a different party implies repayment. Again, the legal requirement is given in writing. Otherwise, it becomes null. However, there are moral obligations as well, and they do not necessarily involve money.

In the previous example discussing a politician’s obligation to represent people, the legal aspect is part of the game too, but most commonly, politicians have unwritten obligations – not just towards the people voting for them, but also towards their donors.

However, such obligations cannot be properly regulated because no one can prove anything. The same rule may apply to the obligation to repay as well, but only if it is written. If you borrow money from someone you know, you will not be legally punished for not repaying – it will only affect your relationship.

This is why a contract is needed when dealing with finances. Such legal systems have been initially introduced by Romans and still represent a solid solution these days. They are enforced by the law, within some circumstances, of course – for example, the agreement must be legal.

How collateralized debt obligations work​

The collateralized debt obligation – CDO – is a more sophisticated financial structure. It works on the same operating principles, but it is more detailed and complex. It is not just a loan by itself, but backed by a series of loans and different assets.

Such assets will normally end up sold to investors. From a financial point of view, a collateralized debt obligation is a derivative. Such things were extremely common throughout the financial crisis of 2008, especially in real estate.

The first CDOs were introduced in the late 1980s. They are known to be collateralized simply because the repayments of the assets can be used as collateral. This collateral is what defines the value of the CDO.

Securities firms came up with their own CDOs later on, but they were mostly focused on predictable income sources. For example, they targeted student loans or perhaps auto loans. This was a niche product until the beginning of the 21st century – more popular than ever today.

Defining the ability to meet debt obligations​

The so called debt ratio is what makes the difference when banks determine your obligation to repay. It makes no difference if you need a loan for personal needs, a mortgage, a business loan, or any other type of loan.

This debt ratio determines the ability to pay and meet your obligation. It is a ratio covering the total debt and the total amount of assets. Such things are normally valued by the lending institution, regardless of your own valuation.

The solvency ratio is another aspect worth some consideration, not to mention liquidity.

The process is pretty much the same for both people and companies, but with some differences. People, for instance, have a credit score, which is calculated based on how good you are with bills, late payments, current debt, and so on.

In some countries, businesses also have a credit score. Even if a company is extremely liquid, a poor credit score will reveal plenty of negative details from its past, so financial opportunities will not be too diversified.

It pays off double-checking the credit score before applying for a loan. Your obligation to repay will not be affected, but there are things you could do to increase the credit score – such as taking smaller amounts of money and repaying everything before interest kicks in or perhaps correcting mistakes.

Credit scoring can be defined as a system. Creditors use it to figure out how risky you are. The lower it is, the more likely you are to be rejected. Missing payments or having lots of debt shows creditors that you are not a reliable person – the same applies if your company has a credit score.

No matter how much credit you want, you will need to complete an application. This application tells the lender a few details about yourself – each detail counts some points. The final score will determine how much money you are likely to get.

A poor credit score may not necessarily mean rejection. Sometimes, you can still get the money you want, but the terms and conditions are stricter. For instance, more risk means higher interest rates or lower amounts of credit.

Each creditor will use a different company or system. Therefore, just because one creditor may refuse you or give you bad terms, it does not mean that all of them are the same. You may find the deal of a lifetime somewhere else.

The federal government and states in the USA – Any obligations?​

Again, the obligation to repay is not all about money and repayment. Sometimes, it can be a legal obligation that involves no money at all – most countries have such obligations. Take the USA, for example.

The federal government has an obligation to each state. Practically, each state is free to come up with a republican type of government. Each state can also protect itself from an invasion or perhaps protect itself against domestic violence – especially when asked to do so by local laws and regulations.

These are some legal obligations that involve no financial services at all.

Terminating the obligation to repay​

Whether it is someone getting a loan for personal needs or a company dealing with a business loan, they have the right to terminate the contract and even ditch the obligation to repay under certain circumstances.

Obviously, the lender is less likely to be the one terminating the contract – they want their money, and they want the interest on it. This is how most financial institutions actually make money. They do have the right to take you to a court or aim to repossess things if you fail to repay.

But then, contractual obligations can also be terminated. Fraud is one of the easiest reasons to terminate such a contract. It is less common, though – after all, most lenders have teams of lawyers ensuring everything is done by the book. This is also why their contracts are so detailed.

A breach of contract is another reason wherefore contractual obligations can be terminated. Again, the lender is less likely to do it due to covering themselves with sophisticated contracts that may even include an increase in the interest rates.

Finally, the contract can also be terminated if both parties agree to do it. There will be some harsh terms though, unless there is a mutual mistake – or, as experts refer to it, the impossibility of performance. Lenders will try to gain as much as possible before such a termination though.

Conclusion​

As a short final conclusion, the obligation to repay is not always enforced by a legal agreement. Without a contract, you do not necessarily need to repay, and you can prove yourself innocent in court. However, no one is going to give you money without a contract unless you manage to convince family or friends.

In such situations, failing to meet the obligation to repay can ruin personal relationships.
 
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