Secured versus unsecured debt

Secured vs Unsecured Debt: How is an Unsecured Debt Different to a Secured One?

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While being in debt is never an ideal position to be in, becoming a debtor is sometimes inevitable.

Whether you need quick cash for paying monthly bills, or you are applying for a student loan, you should know that debt repayment is a long and exhausting process which is pretty stressful unless you have an effective budget plan and proper spending habits.

Making a choice between different loans and credit cards is important in order to carefully plan your repaying strategy without ending deep in debt.

There are a number of different loans and credit options, but all debts are classified under two main categories – secured and unsecured debts.

Right from the start, there is one main difference – a secured debt includes present collateral (a car, house, other property) that can be taken away as a consequence of missed debt repayments.

Unsecured debt doesn’t include collateral, and your property can’t be taken away until the court issues a money judgment to the creditor. You probably think that unsecured debt is always the better option, but this is not the case.

In order to understand the difference and know which kind of loan is adequate for your specific situation, we have to get a better insight on the matter.

How Do Unsecured Debts Work?

The What Lies In Your Debt platform offers a great explanation on the difference between these two and provides a number of tips on repaying them. As we mentioned above, collateral is absent in unsecured debt. What this means is that the creditor can’t ask for your property in the repayment process, unless the court has issued them a money judgment.

As the term itself says, this type of a debt is not backed by any kind of security method, and the only thing that the borrower takes in consideration is your credit score and word that you will be making regular monthly payments. Still, it is not all that simple, and creditors do take a number of precautions before issuing such a loan.

Secured verus unsecured debt credit score

First, only people with a high credit score and good repayment history will be eligible for high unsecured loans. Along with that, higher monthly income can be a requirement as well.

Banks put up higher interest rates that are adequate to the amount of risk they are taking. Apart from high-interest bank loans, common examples of unsecured debts are student loans, medical bills, as well as outstanding credit card balances.

A credit card is a perfect example of how an unsecured debt works – you get a specific amount of credit you can spend but pay high-interest rates as a consequence of such an option. Interest rates in unsecured debts depend on who is allowing the loan as well – a government issuing treasury bills is always going to have lower interest rates than an individual creditor entity.

But what are the options of your loan lender in case you are not making the regular monthly payments? As we have mentioned, the creditor can’t ask for your property without an issued money judgment. On the other hand, they do have a number of other repayment instruments.

Firstly, they can hire a debt collector to serve you and pursue you in repaying the existing debt. If that doesn’t work, going to court is always an option. Lastly, unsecured loan creditors do everything in their power to inform the relevant credit bureau about your non-paying behavior, and thus lower your credit score.

While an unsecured debt carries a high amount of risk, the creditor still has enough options to make you repay it.

How Does a Secured Debt Work?

The main difference between an unsecured and secured debt is the fact that the latter has a collateral backing included in the loan contract. What this means is that a lender can use the borrower’s property to repay the existing debt.

The most common type of a secured debt is a mortgage as well as a car loan. Along with that, personal finance loans and security agreement store charges fall under the secured debt category and include collateral as a secured method. You should know that whether your house, car, or title is set as collateral, you don’t have full ownership over it until you completely repay the debt.

It is clear that a secured debt carries a much lower risk, which means that obtaining a secured loan includes fewer requirements. The borrower in a secured debt has a bigger motivation to repay it on time than an individual in unsecured debt, as the first one is backed by an asset.

It is not rare that the creditor asks for the asset to be maintained and insured – in case any damage occurs on the relevant asset, the lender will still manage to sell it for an adequate price or get insurance coverage. By joining the What Lies In Your Debt platform you will get an even better insight and tips on the instruments you have as a secured debtor.

What If You Can’t Repay Both?

In the scenario where you have a secured and an unsecured debt, and you don’t have enough funds to repay both, you will have to make a decision based on debt prioritizing.

While you should take care of unsecured monthly payments once you are back on your feet, paying secured debt is more important for the time being. Secured debt is backed up by collateral which means that you are at risk of losing your property or house if your repayment behavior is inconsistent.

On the other hand, if you have some extra cash on you for the month, making an extra payment to the unsecured debt is a better decision. This way you will be able to pay it off faster and escape even higher interest rates.

What Lies In Your Debt

Final Thoughts

Both secured and unsecured debts have their own purpose and repayment methods.

Consolidating your spending habits and making an effective budgeting plan (after consulting with your financial adviser) will go a long way towards your long-term financial stability.

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