What is the difference between secured and unsecured debt?

What is the difference between secured and unsecured debt?
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  • Tvine
| Mar 15, 2023
Reviewed, Jun 6, 2023

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    When it comes to borrowing money you have 2 options – secured vs unsecured loan.
    Both of these options come with their own set of advantages and disadvantages, and it’s essential to weigh them carefully to determine which is the best fit for your financial needs.
    Debt is intimidating for many but if you learn about how it works and how to manage it successfully, it’s a great financial tool.

    Key Highlights

    • The primary difference between secured debt and unsecured debt will be the collateral. Collateral is what will be used if you cannot make the repayments anymore. A secured loan will be backed by collateral.
    • Having collateral on your debt will generally lower the interest rate of your loan and allow you to borrow more and for longer.
    • Whichever type of loan you pick comes with a set of penalties for missed payments so it’s important to have a repayment strategy in case of unexpected hardship.

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    What is secured debt?

    Secured debt is a type of loan that is backed by something of value that you own, the collateral. Typically, the collateral will be a house or a car. This means that if you fail to pay back the loan, the lender can take possession of the item that you pledged as security for the loan in order to recover their money. 

    What are some secured debt examples? 

    Let’s look at some examples of secured debt.

    Secured Debt Examples

    There are several types of secured debt, some will have the item that you’ll purchase as collateral such as an auto loan or a mortgage and some could have cash deposit, inventory or equipment as collateral.

    Mortgages and auto loans are common types of secured loans. For instance, if you fail to make the loan payments on your car loan, the lender will be able to claim ownership of the vehicle in order to recoup their money.

    Secured credit card issuers often require a certain amount of cash as a security deposit but then, you’ll be able to make purchases with it in similar ways to regular credit cards.

    What happens if you don’t pay secured debts?

    Understanding the risks associated with missing payments of secured debt is paramount when getting a loan or a mortgage.

    What Happens if You Don’t Pay Secured Debts?

    If you fail to make your planned payments, the lender will be able to claim the loan collateral. On top of risking losing your collateral, there may be other repercussions such as penalty fees for failed payments and the chances of getting a lower credit score that will affect any future loans.

    That’s why it’s very important to understand the terms and conditions of a loan before signing the paperwork.

    What is unsecured debt? 

    Unsecured debt is a type of loan that isn’t attached to any collateral. These types of loans don’t require a deposit or something that will be recovered by the lender in case of failed payments.
    Most personal loans fall into the category of unsecured debts.

    What are some unsecured debt examples?

    Let’s look at some examples of unsecured debt.

    Unsecured Debt Examples

    Unsecured debt is based on the creditworthiness of the borrower and rests on a high-interest line of credit. The higher the credit score and credit history are, the more likely to get accepted for such loans. This will also affect your credit limit.

    Banks and store credit cards, personal loans, student loans and medical bills all are types of unsecured debt.

    The lower your credit history and credit score, the harder it’s going to be for you to be eligible for these financial products. On the other hand, anyone with a good credit score and adequate credit history can have access to unsecured loans without needing collateral. Thus, making it attractive to borrowers who may not have spare cash for a security deposit or items such as a home to put as collateral.

    What happens if you don’t pay unsecured loans or debts?

    Unsecured loans come with a series of penalties, as well, if you fail to repay the loan within the agreed time.

    What Happens if You Don’t Pay Unsecured Debts?

    If you miss payments or cannot make regular payments, you’ll be confronted with late fees and other penalty charges. Your inability to make timely payments can affect your credit score and may appear in your credit history.

    The worst case scenario, if you don’t pay, will be that your debt will get sent to a debt collector.

    What is the difference between secured and unsecured debt?

    In this section, we will look into the key differences between secured and unsecured debt. 

    Secured vs unsecured debt

    These differences are mainly around the need for collateral, financing terms, and credit score criteria. Understanding these elements is crucial to increasing your chances of getting approved for a loan.

    1. Collateral requirement

    In summary, secured debt is backed by collateral, while unsecured debt is not. Collateral can be any asset in your possession such as a piece of real estate, a car or any other valuable asset or cash that you own.

    With unsecured debt, you won’t risk any of your assets as no collateral is required.

    2. Financing terms

    Secured debt typically carries lower interest rates than unsecured debt because the lender has a way to recover their investment if the borrower defaults. The lender may also create a lengthier repayment plan and offer a bigger loan.

    Unsecured debt, on the other hand, is riskier for the lender and carries higher interest rates as a result.

    3. Credit score criteria

    For secured debt, the credit score criteria are generally more lenient than for unsecured debt because the lender has collateral to fall back on.

    Lenders are more cautious about issuing unsecured credit and may have stricter credit score criteria. Generally, a credit score of 670 or higher is considered good for unsecured credit, but some lenders may require a higher score.

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    Choosing between secured vs unsecured debt

    Ultimately, the choice between secured and unsecured debt depends on your individual financial situation and borrowing needs. If you have collateral to offer and are looking for lower interest rates, secured debt may be the better option. If you don’t have collateral or need the money quickly, unsecured debt may be the way to go. 

    Final Thoughts

    It’s important to note that lenders consider many factors when evaluating a borrower’s creditworthiness. Other factors, such as income, employment history, and debt-to-income ratio, are also taken into account. So, it’s important to carefully consider the terms of any loan before borrowing to make sure you can afford the payments and meet the repayment schedule.

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