A secured debt is secured by an asset that the lender can confiscate if you fail to make a payment, while an unsecured debt is secured only by your name and credit profile. Borrowing money – whether through a credit card or taking out a personal loan – means creating a debt that you must pay off, usually with interest.
Whether it’s unsecured debt or secured debt, it can affect how you decide to prioritize. Here’s how to tell the difference between secured and unsecured debt and why it matters.
What is secured debt?
Secured debt is a loan or line of credit secured by some type of collateral that is of equal value to what you are borrowing.
Secured loans and debts may include:
- Mortgage
- Auto loans
- Real estate loans or lines of credit
- Protected Credit Cards
- Secured business loans
“If you don’t pay, lenders can seize the asset that serves as collateral,” says Cathy Ross, executive vice president of American Consumer Credit Counseling.
However, secured debt also has a positive side, says Connor Brown, personal finance expert and founder of After School Finance.
“Secured debt usually has a lower interest rate because the lender has a source of collateral if you don’t make your payments,” Brown says. “Mortgage loans, home loans and auto loans usually have low rates because they are secured by collateral with a fairly predictable value.”
If you use a car or house as collateral, the lender can make an accurate guess about what it will be worth over time. Depending on your credit history, this may result in lower interest rates and lower monthly payments for you.
What is unsecured debt?
Unsecured debts are not secured by collateral, so the lender has no assets to confiscate if you fail to make a payment. There is still a promise on your part to pay, but you don’t have to risk your car, house, or other property to get a loan or line of credit.
Unsecured debts may include:
- Most credit cards
- Personal loans
- credit lines
- Federal student loans
- Private student loans
- Peer Loans
- medical debt
- Small Business Loans
If you default on any of these types of unsecured debt, you do not risk losing collateral. But there could be other consequences, Ross says, including debt collection, civil court action, and forfeiture of your wages or bank accounts.
You can run into these things if you default on unsecured debt on a credit card or line of credit, a personal loan, a private student loan, or medical bills. If you have defaulted on your federal student loans, the government may also provide you with a tax refund to help pay off your debt.
Secured Debt vs. Unsecured Debt: Which is Better?
If you are wondering whether it is preferable to have secured or unsecured debt, the answer is not so clear cut.
“Secured debt is used for a variety of reasons and is not necessarily bad,” says Don-Marie Joseph, founder of Estate Planning & Preservation in Williamston, Michigan.
For example, a secured loan is a must if you are getting a mortgage to buy a house. And Joseph notes that in some cases, you can use secured credit cards, loans, or lines of credit to fix bad credit scores.
Similarly, some unsecured debts, such as federal student loans, are generally considered “good” debt because they are used to invest in your education. Meanwhile, credit card debt – with its high interest rate – is not usually considered profitable.
What makes one debt “better” than another may depend not so much on whether it is secured or not, but on the following factors:
- Interest rates and fees
- Annual interest rate
- What is it used for
- Positively or negatively it will affect you financially
And finally, what really matters is how you handle each type of debt you owe.
“Regardless of the type of debt, if you don’t pay it off, it will negatively affect your credit history,” says Brown.
For FICO credit scoring, the longer a bill is held up or not paid, the worse the impact on your score becomes. And negative information, such as late payments, missed payments, collection accounts, and write-offs, can remain on your credit report for up to seven years.
Manage secured debt versus unsecured debt
If you have multiple debts, it’s helpful to have a plan to pay them off. The best solution for you may depend on the type of loan and interest rate. Your financial situation may also influence your decision.
There are several different methods to help you pay off your debt as quickly as possible.
If you are in financial trouble, you can first pay off debts that have assets tied to them, such as a mortgage or car loan. Keeping track of these payments can help you avoid losing your home or car.
Missed payments on unsecured debt can hurt your credit, but there is no immediate danger of losing any assets. If you’re worried about staying on top of your debt, remember that your creditors and issuers may have options to help.
For example, you can get a temporary mortgage payment deferment, defer or defer your federal student loans, or apply for a hardship relief program with your credit card company. All of these can be helpful for managing secured and unsecured debts while maintaining your credit as much as possible.
And even if your finances are on solid ground, think carefully about increasing your debt load.
“Do your research before opening new credit cards, taking out a new car loan, taking out a student loan, and so on,” says Ross. “Understand your loan terms and interest rate to make sure you can actually afford the payments.”
bottom line
An easy way to tell the difference between secured and unsecured debt is to look at what supports it. If a valuable asset is tied to debt, it is secured, and if the debt is secured only by your name and credit rating, then it is not secured.
Understanding how to prioritize secured debt over unsecured debt will help you make better financial decisions. Always remember that defaulting on secured debt can mean you lose the asset backing it, but defaulting on unsecured debt can mean a devastating blow to your credit score.
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