What is the difference, if any, between secured and unsecured debt? Both are debt, and isn’t debt, debt? What makes unsecured different than secured? Well, let us take a look and see.
Unsecured Debt
Unsecured debt is a finance term that refers to any obligation that is not collateralized. Collateral is something of value that you own, or an asset that you put up to secure a loan or debt obligation. 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 rights to any collateral for the money borrowed. 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 coax you to pay the amount owed. If that doesn’t work, the lender may sue you and ask the court to garnish your wages, take an asset, or put a lien on another your assets until you’ve paid it off.
Common examples of unsecured debts are arrangements such as credit cards, medical bills, student loans, and store cards where you do not have to put up any material as security for the amount borrowed.
Also called signature loans or personal loans, unsecured debt is often used by borrowers for small purchases such as computers, home improvements, or unexpected expenses. With unsecured amounts there is no tangible property or any other kind of product that is attached to those funds.
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, which in turn makes the loan more expensive. The more additional risk that a lender must take on, the higher the rate of interest a borrower must pay, making unsecured loans subject to higher rates. Additionally, you have set payments over an agreed period of time and penalties may apply if you want to repay the loan early.
Secured Debt
In contrast to a secured debt, if the creditor can take an item of property away from you to cover the amount you borrowed, than you are working with a secured loan. If the lender has to take your asset because the account becomes delinquent, the asset will be sold. If the selling price for the asset doesn’t completely cover the debt, the lender may pursue you for the difference.
The basic difference between secured and unsecured debts is that there are tangible items that are attached to the debt. Debts such as mortgages and car payments usually have tangible items attached to it, i.e.: your house or car. Secured balances are tied to an asset that’s considered collateral for the amount borrowed. 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 your auto loan is secured 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.
The big difference between the two types of debts happens or is applicable when someone files for bankruptcy. In Chapter 7 Bankruptcy you can make the choice of both keeping the product or property and paying off the debt in some way. But if you decide that you cannot pay at all then you also have the option of giving the product or property back and paying off your debt in 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 loans. 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?
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