Secured vs. Unsecured Debt
How to tell the difference between these two types of debt and why it matters
Mortgages, student loans, credit card and auto payments are all examples of debt, yet each functions a little bit differently. One of the main ways they differ is whether or not the lender requires you to provide collateral- an asset that functions as a backup for your loan in case you default. This distinction can help you understand whether debt is secured or unsecured. It also can help you learn how particular loans function, and decide how to prioritize paying off your debts.
Secured debts are backed- or secured- by an asset that acts as collateral for a loan. With a secured loan, your payment is directly tied to this asset. The lender, or lien holder, is legally allowed to seize the asset and use it to pay your debt if you miss a certain number or payments.
Let's say you've take out a loan to buy your home, and you've agreed to make monthly mortgage payments of a specified amount. If you become delinquent, or even default on your loan by missing too many payments, the lender may decide to start foreclosure proceedings, which means they will repossess your house, kick you out in the process. The same goes for your automobile;: if you neglect your monthly auto payments long enough, the lender can confiscate your vehicle.( Ever heard of the repo man? That's where he comes in- presenting up at your house to literally repossesses or take back, your vehicle .)
In both cases, the lender has the right to sell the assets to recover some of the money they're owed- and if the sale doesn't cover the entire debt, you may have to pay the difference.
With any secured debt, you don't completely own the asset until you've paid off the loan in full. Once you pay it off, however, you can ask the lender to provide a new title for the asset, thereby "releasing" it- meaning it's yours forever, or at least until you decide to sell.
Secured debts are typically easier for borrowers to obtain because the collateral make-ups them less risky for lenders to issue. And these types of loans are extremely important to repay, because defaulting on a secured loan could mean losing your shelter, transportation or another important asset.
Unsecured debts are not tied to a particular asset, which makes them riskier for lenders. To balance that higher risk, lenders build borrowers pay more in interest. And while you may not have your house taken away from you for missed payments, defaulting on unsecured debts can still have consequences.
Credit cards, student loans and personal loans are all examples of unsecured debt. So are medical bills and court-ordered child support. If you default, you may be subject to late fees and other penalties. Fail to pay too log and your lender will likely take measures to collect payment. These measures can include hiring a debt collector to track down the money, asking the court to garnish your wages- meaning, take a chunk out of each paycheck to put toward your debt- or putting a lien on an asset until you pay. The lien is your lender's way of staking their claim to y our asset, and it prevents you from selling it, transferring ownership or utilizing it to secure other debt.
For example, if you rack up a large credit card balance and don't pay it in full each month, the balance will continue to grow, accruing interest on top of the original quantity owed. If you stop paying the bill for a period, the credit card company might turn your account over to collections. Debt collectors will contact you any route they can- telephone, email, maybe even showing up in person- to arrange a payment plan.
Your lender can also report your delinquent status to the credit-reporting bureaus. These organizations track your debt information and compile the credit score that lenders use to determine whether to give you a loan. While timely unsecured debt payments can improve your credit score, missed payments and delinquency can hurt your credit score. A low score constructs it herder to get the best terms from lenders, and may even keep lenders from giving you a loan.