Secured and Unsecured Debt

What is the difference, if any, between secured and unsecured debt? Both are debt, and isn’t debt, debt? What makes unsecured debt different than secured debt? Well, let us take a look and see.

What is Unsecured Debt

Unsecured debt is a finance term that refers to any debt obligation that is not collateralized. Collateral is something of value you own or an asset you put up to secure a loan or debt obligation. With unsecured debts, there is no tangible property or other product attached to that debt.

In the case of unsecured debt, a lender loans money without the security that an underlying asset provides. 

With unsecured debts, lenders don’t have the right to any collateral for the debt. If you fall behind on your payments, they don’t have the right to take any of your assets. However, the lender may take other actions to get you to pay. For example, they will hire a debt collector to collect the debt. If that doesn’t work, the lender may sue you and ask the court to garnish your wages or take an asset. The lender can also put a lien on another of your assets until you’ve paid your debt.

Examples of Unsecured Debt

Typical unsecured debts include credit cards, medical bills, student loans, and store credit cards where you do not have to put up any material as security for the debt.   

Also called signature loans or personal loans, borrowers often use unsecured debt for purchases such as computers, home improvements, or unexpected expenses. 

An unsecured loan means the lender relies on your promise to pay it back and nothing more. For this reason, unsecured debt carries more risk for the lender, making the loan more expensive. The more additional risk a lender must take on, the higher the rate of interest a borrower must pay, making unsecured loans subject to higher interest rates. Additionally, you have set payments over an agreed period, and penalties may apply if you want to repay the loan early. 

What is Secured Debt

In contrast to secured debt, if the creditor can take an item of property away from you to cover the debt, you are working with a secured debt. The creditor will sell the asset if the lender must take your asset because the account becomes delinquent. If the selling price for the asset doesn’t completely cover the debt, the lender may pursue you for the difference.

The fundamental difference between secured and unsecured debts is that tangible items are attached to the debt. Debts such as mortgages and car payments usually have tangible items attached to them, i.e., your house or car. Secured debts are tied to an asset and considered collateral for the debt. Lenders place a lien on the asset, giving them the right to take the asset if you fall behind on your payments. So, for example, your mortgage loan is secured by your home, and auto loan by your vehicle.

In a secured debt situation, as the borrower or person seeking the loan, if you were to file bankruptcy, failed to pay the debt obligation, or failed to meet the terms for repayment, the asset that secured the loan that you put up to cover the loan, would cover the debt.

Debt and Bankruptcy

The big difference between the two types of debts happens or is applicable when someone files for bankruptcy. In Chapter 7 Bankruptcy, you can choose to keep the product or property and pay off the debt in some way. But if it is decided that you cannot pay at all, you also have the option of giving the product or property back and paying off your debt that way. On the other hand, in Chapter 13 Bankruptcy, you are allowed to keep the merchandise or property, but you will be allowed to pay off your debt according to the Chapter 13 plan.

There you have it—the difference between unsecured and secured debt. There is a difference, and it can be a big one. Know what you are getting when you take on debt. Is it secured or unsecured? Comment below. I would love to hear from you.

Concerning Your Net Worth Statement

After analyzing your net worth statement, you may have some concerns.  These concerns may include low assets, high liabilities, or negative net worth.  You will want to address these opportunities.  The net worth statement may also provide information that will lead to the development or revision of goals and objectives. 

In my last post, I talked about the net worth statement.  Also called a balance sheet, it is a tool you can use to see if you are making progress towards your goals and objectives.  You can read the last post by clicking here. 

In this post, I wanted to discuss some of the issues or opportunities concerning your net worth statement.  The net worth statement keeps you informed about your overall financial standing.  It lets you know if your net worth is decreasing or increasing.    

Valuing Assets and Labilities

First, a key to the net worth or balance sheet is determining good values for assets and liabilities.  And because you are using this net worth to compare to other years, you need the values to be as accurate as possible.  Therefore, you will want to use the same valuing tool.  For example, if you are valuing a car, and you use Kelley Blue one year, you may want to use Kelley Blue Book to value the car next year.  Otherwise, if we don’t get good values for assets and liabilities, what’s the use to comparing it to prior and future years. 

Addressing Net Worth Concerns

After analyzing your net worth statement, you may have some concerns.  These concerns may include low assets, high liabilities, or negative net worth.  You will want to address these opportunities.  The net worth statement may also provide information that will lead to the development or revision of goals and objectives.  For example, you may create an objective to change a negative net worth to positive net worth. 

Increasing Net Worth by Cutting Spending

As a financial counselor, I would help clients increase their net worth by showing them ways to increase their assets, decrease their liabilities, or both.  One way to increase assets is to cut back on spending.  This will allow for the building up of savings which will increase net worth.   Investing is another opportunity for some to increase assets.   

As you are addressing opportunities, keep in mind that that decreasing spending will have the greatest impact on net worth.  The reduction should focus on larger asset items such as housing and transportation. Reducing spending on smaller daily expenditures will not have the same impact.

The Effect of Increasing Income

Another way to increase net worth is to increase income.  If you can negotiate a pay raise, find part-time work, or sell your products or services, you can use the increase to build savings and pay down debts.

Paying Off Debt and New Worth

Finally, paying off debt can quickly increase net worth. Paying off high-interest credit card debt can have the most immediate impact on net worth. Freeing up cash by reducing spending or increasing income can be a great start toward a debt repayment plan.

All Net Worth is Not the Same

A person who does not currently have the financial resources to pay off all existing debt is considered insolvent. Their liabilities are more than their assets.  This situation is frequently found among students and recent college graduates who have incurred student loans and have not yet built-up assets to offset debts.  Considering where an individual or family is in their financial life cycle, insolvency or a negative net could be expected.  A negative net worth due to student loans or the purchase of a home is not the same as a negative net worth due to credit card bills or the accumulation of lifestyle assets or assets that don’t produce disposable income

Finial Thoughts

As we start a new year, you may want to create a net worth statement to see where you stand financially.  Once you have an idea of your net worth, you can develop objectives and goals to improve your financial situation.  However, you can always commit to spending less than you make and increase your rate of saving in this new year.  This will always move your finances forward in the new year.

Time To Update Your Net Worth Statement

If you would like to gain some insight into your current financial situation creating a net worth statement may be for you.  It’s a listing of the property you own, assets, and the debts you owe, liabilities, can provide you that insight.  Sometimes it’s called a balance sheet and is based on the following:

Assets = liabilities + net worth, or assets – debts = net worth

The net worth statement is like a photograph of assets and debts on a given date.  Comparing net worth statements made over several years can help you measure the progress toward your financial goals and financial situation.  Additionally, the net worth statement is a good measure of your ability to pay off current debts, or debts due within the year. 

Developing the Net Worth Statement

Most net worth statements are created at the end or beginning of the year which makes them easier to compare year over year.  However, it is possible to develop a statement at any date and as often as needed. 

Listing Assets

Generally listed on the left-hand side of the balance sheet, you want to start by listing your largest assets which for most of us this would be our home and then vehicles.  And you also want to list your more liquid assets like checking and savings accounts.  Additionally, gather statements and list any investments and retirement accounts.  Also, consider personal items that may be of value.  This could include jewelry, coin collections, musical instruments, etc.   You don’t need to itemize everything, but list items worth $500 or more.  Now, add all of items listed together.  This number represents your total assets.  

If you obtain your current checking account balance, remember to subtract the value of anything still outstanding.  Keep in mind that the key to correctly listing current assets is to accurately estimate the value of items.  Therefore, be conservative with estimates, especially with home and vehicle values. Inflating the value of large assets is easy to do and will not paint an accurate picture of your net worth.

Listing Liabilities

Liabilities are generally listed on the right-hand side of the net worth statement and include all debts and obligations to pay.  Start with the major outstanding liabilities such as the balance on your mortgage or vehicles loans.  Next, list all of your personal liabilities such as credit cards, student loans, or any other debt you may owe.  Now you want to add up all of your liabilities to come up with a total.

Your Net Worth Statement

Once you have your total assets and total liabilities, subtract the total liabilities from the total assets and you will have your net worth.   It doesn’t matter how big, how small, or even if it is negative.  This is just a starting point. You will want to file it so you will have something to compare against in the future.  Now you want to repeat this process, during the same period once a year, and compare it with the previous year’s number.  

Your net worth statement can be a useful tool to measure your financial progress from year to year.  There is no magic net worth number, but you should use your net worth to track your progress from year to year, and see it improve.  In my next post, I will address some net worth concerns and how you can improve on them.  I am a financial counselor.  Contact me here if I can assist you with creating a net worth statement.   

How is your Financial Health?

If you are taking better care of yourself, you are probably exercising and know what your blood pressure and cholesterol numbers are.  Therefore, it stands to reason that if you are trying to be healthier financially, you would need to know things like what your assets and liabilities are. 

Many are looking toward the end of this year and the beginning of the next with better financial health.  And every New Year people decide to become healthier and vow to improve their physical health, so they start exercising and eating healthier.  And then others decide that they want to be healthier financially and want to improve their financial health, but do not know quite how to go about it.  A financial checkup may be in order.    

If you are taking better care of yourself, you are probably exercising and know what your blood pressure and cholesterol numbers are.  Therefore, it stands to reason that if you are trying to be healthier financially, you would need to know things like what your assets and liabilities are.  How can you better manage your finances without knowing what your finances look like?  

Similarities of Financial Health and Physical Health

On the surface, there are striking similarities between your financial health and physical health. 

Both can affect aspects of our life and require collecting information, evaluating alternatives, and taking some risks.  However, it seems health issues have received a lot more attention than financial issues. 

There are dangers of focusing on a single aspect of your finances. 

Tending to retirement savings without dealing first with high credit card debt is perhaps equivalent to treating high cholesterol while ignoring high blood pressure numbers. 

If you want to be healthy, financially, and physically, you cannot get by with just a healthy right leg or a well-managed retirement plan.  The whole system must be healthy.  But while many of us are willing to undergo regular health check-ups, many people never undergo a financial check-up.

Achieving Better Financial Health

The first step in better financial health is to have an accurate snapshot of just what shape your finances are in.  By having a good sound understanding of both your assets and liabilities, you can start planning a healthier financial lifestyle. 

Next is to track your spending.  Knowing where your money is being spent; where your money is going, is paramount in managing your finances better and improving your financial health. 

Your assignment for the next month or so is: 1. pull together your assets and liabilities to get an accurate picture of your finances, a balance sheet or net worth statement, 2. Track you’re spending so you can see where your money is going. 

My number one financial tip is that you cannot effectively manage your finances without knowing where your money is going…track your spending. 

So, start today because today is the first day of the rest of your life. Only you can make the most of it.  Take charge of your financial health. The key to your future is in your hands, not your employer’s and not your family’s.  Comment below.  I would love to hear from you.