When it comes to debt, borrowers typically deal with two different types: secured and unsecured. As a consumer and a borrower, understanding the difference between these types of debt is important. Whether a debt is secured or unsecured may affect the interest rate as well as whether an asset you have is at risk if you have trouble repaying the debt. Look at what is considered unsecured debt and secured debt, so you have a better understanding of the lending choices that are available to you.
Secured Debt
A secured debt is a debt that uses a borrower’s asset as collateral for the loan. When a secured debt is issued, lenders place a lien on the borrower’s asset. The purpose of this lien is to lower the overall risk the lender is taking in issuing a loan. The collateral helps ensure that the lender will get the value of the loan back if the borrower defaults. If a borrower on a secured loan runs into trouble paying it back, the lender can seize the asset in question. When it does so, the lender typically sells the asset at auction at a discounted rate to recover the value of the loan on which the borrower defaulted.
As described earlier, borrowers can encounter many different types of loans that are typically issued as a secured debt. Since mortgages and car loans are issued to finance an asset, they typically use the home or automobile in question as collateral. However, there are other types of secure loans. Home equity loans and home equity lines of credit, or HELOCs, are typically issued as secured loans as well, using the home in question as collateral. If a borrower plans to consolidate all credit card debt into a single new loan, he or she may encounter a secured debt consolidation loan, too. Finally, some secured credit card programs use a borrower’s asset to assume the balance he or she accrues on the card.
There are advantages and disadvantages to using secured debt. Because lenders consider a secured debt to be less risky, they’re often willing to issue loans with lower interest rates. Additionally, a borrower taking out a large loan or a borrower with less-than-stellar credit may have a better chance of getting the loan approved if it’s secured with collateral. However, there’s a major downside to using a valuable asset to secure your debt: if you default on your loan, the lender could seize the asset used to secure it. Additionally, the lender may place terms on the loan that make it difficult to sell or modify your asset until the debt is paid off completely.
Unsecured Debt
An unsecured debt doesn’t use a borrower’s asset as collateral for the loan. Unlike a secured loan, if a borrower falls behind or defaults on repayment of an unsecured loan, the lender cannot seize the borrower’s assets as a means to settle the debt. Credit card debt is the most commonly encountered form of unsecured debt. However, student loans, medical bills, and many personal loans that lenders issue are unsecured as well. Many lenders also issue debt consolidation loans that aren’t secured by assets.
If you fall behind on payments on an unsecured loan, you won’t have to worry about the lender seizing your home or car and auctioning it off. However, this doesn’t mean that lenders don’t have other means of recovering debt. When a borrower defaults on an unsecured debt, lenders can use debt collection agencies or legal means, such as garnishing wages, to collect on the debt. Additionally, since an unsecured debt has no collateral, lenders consider it a higher risk. In many cases, these debts will be issued at higher interest rates than they would have been if they were secured. Finally, borrowers who have issues with their credit may be considered too high of a risk to be issued some types of unsecured loan and may have to use collateral to satisfy a lender.
Repaying Secured and Unsecured Debt
If you lose your job, are underemployed, or are just having financial challenges that are making it tough to pay your bills, you should determine whether the debts you have are secured or unsecured. It may make sense to prioritize repaying your secured debts, since defaulting on them could put assets at risk and increase your financial hardships. Additionally, there may be forbearance options available to you on some secured loans, such as mortgages. You should also attempt to contact creditors if you’re having problems repaying your debts, since you may be able to obtain some leeway based on your hardship. Finally, if you feel like dealing with secured or unsecured debts is beyond your capacity, you may want to contact a debt settlement company such as National Debt Relief to secure expert assistance with dealing with your creditors.
Secured vs. Unsecured Debt: Knowing the Difference
Now that you know what is considered unsecured debt and secured debt, you should assess the various loans, mortgages, credit cards, and other debts you have to determine which are tied to collateral. Knowing the differences in the type of debts you have will let you know what type of liens you may have on your property and enable you to make tough decisions faster if you’re ever put into a situation where you cannot pay all your debts on time.
