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Understanding the difference between secured debt and unsecured debt is essential. There are different legal implications for secured debt versus unsecured debt, and if you are struggling to pay all of your bills, there is a different set of priorities for secured versus unsecured debt.
What is Secured Debt?
Secured debt is debt that is guaranteed by an asset. Common examples of secured debt are a mortgage and a car loan. The debt is considered secure or guaranteed because if you do not pay, the bank or lender can take your home or car. Thus, the home or car provides collateral.
Secured debt typically has a lower interest rate then unsecured debt, since the bank knows that they will not lose too much money on the deal. Even if you don’t pay, they can just take the asset that is guaranteeing the loan. This is much safer for a bank then unsecured debt like credit card debt or a personal loan, since if you use your credit card to buy a trip to Tahiti and don’t pay, the bank cant’ exactly seize your vacation pictures to get their money back.
In some cases, credit cards can also be secured. For example, if you declare bankruptcy and you want to rebuild your credit, you may be able to get a secured credit card. In the case of a secured credit card, you put up a set amount of cash- say $500- and then you are given a credit card with a $500 line of credit. You can use that card to charge up to $500, and the cash that you put up as collateral secures the loan.
If you are having a difficult time paying all of your bills, secured debt should always be paid first since it is much easier for a lender to foreclose on your home or car then it is for them to come after you and take your assets to pay unsecured debt.
What is Unsecured Debt?
Unsecured debt is debt
that you guarantee only with your word. In other words, you sign a contract or loan documents and promise to pay back the money, but there is no tangible item on the line as collateral. Personal loans and credit cards are the most common types o secured debt.
If you fail to pay secured debt, a bank can attempt to get a legal judgment against you. If they succeed, they may be able to put a lien on your house, which will prevent you from selling the home. They may also be able to garnish your wages or take other legal actions to get their money. However, they can only do this after they have already gotten a judgment against you, and it is usually much harder for them to force you to sell assets to pay them, if it is even possible for them to do that at all.
As a result, unsecured debt is riskier for lenders and a higher interest rate is usually charged. However, if you can’t pay all your bills, you should pay unsecured debt last, since you cannot usually lose your home over it.
What About Student Loan Debt?
Student loan debt is a unique type of debt. It seems as though it should be classified as unsecured debt, since the bank cannot take back your education and there is no collateral. However, in many cases, student loan debt is secured by the government- which means the government guarantees to the lenders that the loan will be paid back.
More stringent laws also apply to student loan debt; for example, it is not dischargeable in bankruptcy. Thus student loan debt should be paid before unsecured debt.
Understanding the Difference Between Secured Debt and Unsecured Debt
Understanding the difference between secured debt and unsecured debt is essential to a successful financial future. Your credit score is improved by having a mix of both secured debt and unsecured debt and using both wisely, so it is in your best interest to have both secured and unsecured loans.