Secured vs Unsecured Debt
There are two major types of debt – secured and unsecured. Knowing what kind of debt you have is important. Understanding the difference is critical when borrowing money and prioritizing debt repayment. Let’s discuss secured vs unsecured debt!
What is Secured Debt?
Secured debt is secured by an asset, such as a house or car. When you buy a car with a loan, you do not receive the title. The institution from which you borrowed the money, like a bank, holds the title and ownership of the car until the loan is repaid. The asset, in this case the car, serves as collateral for the debt. Hence why it’s called a “secured” debt.
With the title in the possession of the lender, they essentially place a lien on the asset, giving them the right to seize (e.g., repossess or foreclose) it if you become delinquent. If the lender takes the asset, it will be sold to recoup as much as they can of the amount borrowed. For cars, they are usually auctioned while homes are sold as “short sales.” If the selling price for the asset does not cover the entire debt, the lender has the right to pursue you for the difference.
Just remember, you never fully own the asset tied to secured debt until the loan is paid off.
What is Unsecured Debt?
With unsecured debts, there is no collateral and therefore, is riskier for lenders. If you fall behind on your payments, they generally cannot claim your assets for the debt. They have to pursue you in court to recover the debts and ask the court to garnish your wages, take an asset, or put a lien on your assets until you’ve paid your debt. In the case of a credit card, they might sell your debt to a third party, such as a collection agency, to recover the debts.
Lastly, they’ll report the delinquent payment status to the credit bureaus to be reflected on your credit report. Thus, affecting your ability to borrow and skyrocketing your interest rates.
Institutions that offer unsecured debt, mitigate risk by analyzing your credit history, credit score, debt-to-income ratio, and current debts among many other variables to determine how much to loan you. These factors also determine your interest rate and credit card max.
Credit card debt is the most common unsecured debt with over a trillion currently owned by Americans. Other unsecured debts include:
- student loans
- payday loans
- medical bills
- utility bills
- phone bills
- court-ordered child support
Prioritizing Secured vs Unsecured Debt
We all have been in a situation where you’re strapped for cash and are faced with the difficult decision of paying only some bills. In most circumstances, secured debts are typically the best choice. Why? These payments are often harder to catch up with and your asset(s) could be repossessed or foreclosed if you fall behind on payments.
In some instances, prioritizing unsecured debts with extra payments is good practice. Why? Unsecured debts sometimes have higher interest rates, which can take longer to pay off. Even when you’re prioritizing debts, it’s important to pay the minimums on all your accounts.