American household debt totals over $14.6 trillion. This massive number includes several debt types. From small private unsecured loans to large mortgages for home purchases. Securing a loan or other financing is the go-to option for people who need more money than they have. The key to success is knowing what debt type is right for your needs. Understanding the difference between secured and unsecured debt can help you make an informed and strategic decision about your financial future.
What Is Secured Debt?
A secured debt is a loan in which you agree to put up collateral. Typically, these are high-value loans where the creditor takes on more risk. However, they can also be loans for individuals with less than good credit. The borrower agrees to supply collateral to reduce the risk the creditor takes on. The collateral could be a home, car, valuable item, or land. If the borrower fails to repay the loan, the creditor can take possession of the collateral and recoup the loss.
Types of Secured Debt
Typically, secured debt is used to make a purchase, such as a car or a house. However, this isn’t always the case.
- Car loans
- Home loans
- Reverse mortgage
- Home equity loan
- A home equity line of credit
- Secured credit card
Secured Debt Pros
Typically, it is easier for borrowers to get loan approval for a secured loan. The costs for the loan are also lower because the lender doesn’t take on as much risk. Finally, in some situations, there could be tax benefits. Mortgages are secured loan which here borrowers enjoy a tax deduction from interest payments.
Secured Debt Cons
The downside of attaching collateral to your loan is that you risk losing it. If you fail to repay the loan, the lender will come and take possession of the collateral. This means it is no longer yours. Because the collateral is designed to secure the loan, the creditor will want it protected. This could mean purchasing additional insurance, which would be an added loan expense. Finally, secured loans are typically tied to the collateral. This limits your use of the money and makes the loan more limiting.
What Is Unsecured Debt?
An unsecured debt does not require collateral. There is no tangible item reducing the creditor’s risk. This type of debt is typically reserved for smaller loan amounts and those with a very good credit history. The lender isn’t taking on as great of a risk, so they aren’t as concerned about securing the loan.
Types of Unsecured Debt
There are several types of unsecured debt. The most common are credit cards, where you technically take out small loans every time you make a purchase. Unsecured loans can be used for a variety of situations so that you will find a wide range in variety.
- Most credit cards
- Personal loans
- Student loans
- Medical debts
- Store cards
Unsecured Debt Pros
No tangible item is tied to your loan, so you don’t have to worry about immediately losing your house or car. A creditor cannot seize your items on their own simply because you fail to make your monthly payments. Applying for an unsecured loan is faster than a secured loan. Because there is no collateral, there is less paperwork and filing to do. Then once you get approval, you can use your loan for a wide range of purposes. Finally, unsecured financing comes in a wide range of forms. This gives you more flexibility in the type of credit you take out.
Unsecured Debt Cons
Because nothing is securing the debt, creditors are more discerning about how they approve borrowers. This can make unsecured loans harder to obtain. These types of loans also tend to come with less favorable terms. This could include more fees and higher interest rates.
Choose the Right Financing Option
Choosing from these two debt types will depend on your current financial situation, your credit history, and your need for a loan. One type isn’t always better than the other. If you are unsure which type you need, it can help to speak with an attorney. They can help you navigate your options and understand how one may impact your ownership rights to physical assets.
Schedule a consultation with our team of lawyers to discuss the best method of dealing with your secured and unsecured debt.
