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.