You may have already heard that debt or loan can be either secured or unsecured. But what exactly are these two types of debt and what should you know about them?
The main difference between a secured and unsecured debt is the presence or not of collateral. A collateral is an asset, be it property or valuables, that allows you to secure the debt. It acts as a guarantee for the lenders that will be able to seize that asset from the borrowers when they don’t pay off the debt.
Here is what you need to know about each type of debt.
The following are two main types of secured loans:
Mortgage: in this case, the property is used as collateral. If the borrower stood paying the mortgage, the lender has the right to seize the property and resell it to recover the money still owed.
Auto loan: similar to the mortgage, with an auto loan the issuer, can obtain ownership of the car if the borrower fails to pay the monthly rates.
In the above situations, the asset will not be fully yours until you finish paying for it.
Other types of loans can also be secured by collateral:
Personal loan: secured by a savings account, real estate, automobiles or boats, valuables or collectibles. In brief, something that has a significant value can work as a collateral.
Car title loan: consists of giving up your car title to the lender in exchange for the loan. This type of loan can be risky if you are unsure if you’ll be able to pay off the loan but it’s an option for extreme situations.
The benefit of a secured debt is that it can be easier to obtain and it generally has lower interests than unsecured debt. The downside is that it’s riskier for the borrower who may lose the asset used as collateral if he or she cannot pay off the debt.
As opposed to secured debt, the unsecured one doesn’t need collateral. This means that you will receive the loan solely based on your credit score.
The following are types of unsecured debts:
Credit card debt: This is the most common type of unsecured debt.
Student loans: With the price of tuition for secondary education in the US, student loans are extremely common.
Personal loans: They can be both secured on unsecured and they don’t need to be related to specific financial needs.
Medical bills: Unexpected things can happen and sometimes we may not be ready to pay for our hospital bills. These can accumulate under this type of debt.
Rent or utility payments: If you have unpaid bills, those can also be considered a type of unsecured debt.
Court-ordered child support: Not paying child support can lead to more severe consequences but missing a few payments leads to more unsecured debt.
Payday loan: allows you to borrow a small sum of money for a short time. Previously, when asking for a payday loan, you would write a postdated check to the lender that will be able to cash it after your payday, hence the name. Now the process works with bank deposits and withdrawals. These loans usually have a high interest.
Unsecured loans, like personal loans, are definitely less risky than secured ones. But for this reason, you’ll likely pay more interest than with a secured loan. Furthermore, the amount you’ll be able to borrow may be lower, depending on your credit score.
If you have many unsecured debts and you’re looking for a strategy to pay them off with a lower interest rate, they qualify for a debt consolidation loan.