Learn the difference between secured vs unsecured debt, what they are, and how they work with a borrower’s loan.
There are many types of debts and loans in the financial world. One category of debt that is important to understand is secured vs unsecured debts.
This type of debt has to do with collateral, assets, property, and whether the lender has recourse or not.
It’s important for any debt borrowers to be aware of what unsecured debt is and how it works so they can fully understand the terms of their debt agreement.
What is Unsecured Debt?
An unsecured debt is a type of debt that isn’t backed or secured by collateral. This type of debt is not tied to a form of collateral or asset the lender can claim in case of default.
This means that if the borrower is unable to make payments on an unsecured debt, the lender doesn’t necessarily have a right to seize a specific property or asset, because no assets were tied to the unsecured loan.
Borrowers may prefer a form of unsecured debt for the peace of mind of not having to tie personal property or assets to the loan. But unsecured debts can also come with higher costs or stricter credit score requirements to counteract the lack of security.
Example of Unsecured Debt
Some examples of unsecured debts can include any kind of debt that isn’t attached to an asset of some kind. This could include credit cards, medical bills, personal loans, student loans, or utility bills.
- Unsecured credit card
- Medical bills
- Unsecured personal loan
- Student loans
- Utility bills
What is Secured Debt?
A secured debt is a type of debt that is backed or secured by collateral. This type of debt is tied to a form of collateral or asset the lender can claim in case of default.
This means that if the borrower is unable to make payments on a secured debt, the lender may have a legal right to seize whatever property was tied to the secured loan.
Borrowers may prefer a form of secured debt in order to more easily qualify for credit without needing a high credit score. But secured debts can also come with higher risk for the borrower if they are unable to make payments and risk losing their property.
Example of Secured Debt
Some examples of secured debts can include any kind of debt that is attached to an asset of some kind. This could include mortgages, car loans, title loans, home equity loan, secured credit cards, or pawn shop loans.
- Mortgage
- Car loan
- Title loan
- Home equity loan
- Secured credit card
- Pawn shop loan
Secured vs Unsecured Debt
The difference between secured debt vs unsecured debt is that secured debts are attached to an asset or form of collateral, while unsecured debts are not attached to an asset or form of collateral.
But there are a few other key differences that are important to understand as well.
Collateral Requirements
Because secured debts are backed by collateral, the creditor could have requirements of their own for those assets or that property. For example, if you are taking out a car loan to pay for your car, the lender may require you to have a certain type of insurance. Or if you’re taking out a title loan, the lender may require you to bring in your car for an inspection before they will approve the loan.
Credit Score Criteria
Because unsecured debts are not backed by collateral, the creditor could have their own criteria for the borrower’s credit score. Some creditors might require a higher credit score and a credit check before they will approve the loan.
Which Debt Should You Pay Off First?
Between secured debts and unsecured debts, which type of debt should you prioritize paying off first? And should you avoid one in favor of the other?
Debt and credit can be a useful financial tool when used responsibly. Whatever type of debt you get, always make sure you are reading the financing terms carefully.
That being said, it might be a good idea to pay off secured debts first to better protect the assets you have tied to that debt. Another recommendation would be to choose whichever debts have higher interest rates and pay those off first to save money.
Whatever debt repayment method you choose, make sure you keep your personal financial situation in mind and make the best choice for you and your finances.
