Long-term debt is any type of indebtedness that is not likely to be settled within twelve months or less. These debts can be something as simple as a bank loan for a vehicle, a home mortgage, the balance due on bonds issued by a municipality, or any other financial obligation that will require more than one calendar year to settle in full. Properly identifying debt as long-term in accounting records is important for both households and businesses.
The amount of time required for settling the liability is what differentiates long-term debt from short-term debt. While both forms of debt may include the payment of some sort of interest along with repaying the principal, short-term debts are any debts that are expected to be settled in full in less than twelve months. One example would be a short-term loan that would be repaid in a series of six monthly installments. Since the loan would be retired in less than one calendar year, it would be classified as a short-term debt. This is true even though the loan type and the terms other than the duration would likely be very much like those on loans written for the purchase of a vehicle or some form of real estate.
One of the main reasons why understanding the nature of long-term debt is important is that this type of debt can sometimes provide tax breaks for the household or business. Depending on the country of origin, it may be possible to claim the liability on annual tax returns, effectively creating a deduction that helps to reduce the amount of taxable income for the period. For example, many nations allow homeowners to claim a partial deduction for the first several years after financing the purchase of a new home. In some cases, the amount of the deduction is significant, and makes it possible for the household to be classified in a lower tax bracket.
The proper classification of long-term debt is especially important when it comes to making projections of the future financial stability of the home or business. In both scenarios, identifying the duration of the obligation makes it possible to budget accordingly and make sure that all forms of financial commitments, short-term and long-term, can be honored with the amount of earned income projected for the same period. By understanding when a long-term debt will be settled in full, it is possible to determine when to make the next major purchase, or when to embark on some type of new financial venture without possibly putting the household or business into a financial bind.