Unsecured Debt
Unsecured debt and secured debt are two different types. The difference assumes more importance in the event of a bankruptcy or liquidation. Knowing the difference between the two is important for any person interested in securing a debt or when one intends to prioritize debts for paying off.
Whereas a secured debt is backed by an underlying asset or revenues from the borrower, an unsecured debt has no underlying asset. Basically, this means that if the borrower defaults on the repayment of an unsecured debt, the lender has nothing to recover from the borrower to compensate for the costs that have been incurred due to the non-repayment of the loan.
Mortgages and auto loans are examples of secured loans. A mortgage loan is usually secured to the home and the auto loan to the vehicle. In case of non-repayment of the loan, the lender can repossess the property.
In the case of unsecured debts, the lenders do not have any rights to take away the borrower’s property in case of non-repayment of the loan. Examples of unsecured debts include credit card debt, student loans, payday loans, medical bills, etc.
Unsecured debt presents a higher risk for the lenders. They have to sue to get back the money that is owed to them. Because of the higher risk that is involved, the interest rate for an unsecured debt is typically higher.
The lender usually takes a number of actions to get the borrower to pay back in case of default of an unsecured debt. Sometimes, the lender hires a debt collector to coax the borrower into paying back.
Some creditors turn the account to a collection agency which acts on the creditor’s behalf. In extreme cases, the lender can file a suit and get the court to put a lien on another asset of the borrower or get the court to garnish the borrower’s wages.
The lender also provides a report to the credit bureaus so that the non-repayment is reflected in the credit report of the borrower.
Unsecured debt can be discharged by the borrower by filing bankruptcy claims. However, this action can make it more difficult to procure future financing for the next 7 to 10 years.
However, with bankruptcy being more common these days, there have been many who have been able to get a fresh start rebuilding their credit to a certain degree while in bankruptcy by obtaining secured credit. A credit counselor can advise on this after filing bankruptcy though not a suggested path, it can be a useful alternative
In some legal systems, unsecured debts such as child and spousal support payments, student loans, court-ordered payments, fines and government over payments, etc., stay on even after the borrower files for bankruptcy. Some unsecured debts that are wiped out on bankruptcy include credit card balances, personal loans, utility bills that remain unpaid, payday loans, retail store balances that remain unpaid, medical bills, etc.
Debt consolidation is a process by which a single loan is taken out to pay off a number of other loans the borrower has taken out that have become difficult to pay. Most often borrowers opt for a secured loan against a collateral asset to pay off many unsecured loans for better cash outflow management.
It is important to give more priority to pay off unsecured debt because the higher interest rates make it a more expensive option.