Want to know the difference between Unsecured Vs. Secured Debt? Keep reading!
Everyone has some debt in some part of their life, and some people pay them in full without any problem, and some cannot.
There are many reasons behind failure to pay, but there is one that creates a fundamental issue.
Which debt you should pay first, and which one is more important to pay. There are generally two different types of debt, unsecured and secured debt.
Even though they are the same things overall, there is a major difference between them.
This article will explain unsecured and secured debt and talk about which one is more important1.
Key Takeaways
- Unsecured debts are not backed up by collateral, making it difficult to recover in case of a default.
- Unsecured debts come with a very high-interest rate as compared to secured debt.
- Defaulting a secured loan may result in the seizing of the property.
- Defaulting an unsecured loan results in a lower credit score.
Unsecured Debt
Unsecured debts are extremely common types of debts that you have to pay every month due to occasional spending.
There is no collateral backing this debt, making this debt a harder one to seize back in case of default because there is nothing the collector can take from you to overtake their losses.
However, the catch with these debts is that the interest rate is higher than secured debts because the risk is higher for the creditor.
What are the examples of Unsecured debt?
Some examples of unsecured debts could be utility bills, credit card bills, and personal loans which are usually covered by all debt settlement companies.
What happens if I don’t repay my Unsecured debt?
Although unsecured debts are not backed by collateral, not repaying them could still have serious consequences.
Not making your monthly payment towards unsecured debt can result in penalties and extra interest rates.
And if you keep missing out on payments, your credit score will take a hit, and the default history could remain on your report for seven years.
Also, not paying your loans for more than six months can lead to the selling of your account to collections. 2
Pros & Cons of Unsecured Debt
Pros
- Do not need collateral.
- Quick application process.
- Flexible.
- Unsecured credit is available in many forms.
Cons
- Not repaying an unsecured loan can damage credit score & report.
- Harder to obtain.
- Incur high-interest rate
Secured Debt
Secured debts are fundamentally harder to get, and they are generally for higher amounts when compared to unsecured debts.
The main reason for this is that secured debts have collateral backing the debt, like a house or a car.
If you default on this loan, the property you gave as collateral will get seized by the creditor.
These debts have lower interest rates and are for long-term debts like mortgage payments, car loans, etc.
What are the examples of Secured debt?
Auto loans and mortgage loans are the most common example of secured debt. In this, your car or house serves as collateral.
Secured credit cards are also an example of secured debt. You use a secured credit card just as you use a normal credit card.
The only difference is that they require you to make a security deposit to open the account. So this opening fee acts like collateral for them.
What happens if I don’t repay my Secured debt?
There are not one but many negative consequences of not repaying a secured debt.
The biggest thing that could happen is that your collateral will be sized by the lender, and you might also get imposed with penalties and extra fees.
Also, your lenders can report this to the credit bureaus, which will decrease your credit score and damage your credit report. 3
Pros & Cons of Secured Debt
Pros
- Secured debts are easier to obtain.
- You can enjoy tax benefits.
- Interest rates are lower.
Cons
- Risk losing your collateral.
- Less flexible loans.
- May require additional insurance coverage on collateral.
Which One is More Important?
There are several crucial details to know about these debts, but the major thing to know about these two types of debts is the difference between them and which one is more important to pay.
The importance of the debts depends solely on your financial background and what you can afford to lose.
If you don’t pay unsecured debts, you don’t lose anything physically, but your credit score will go down and make you a riskier customer.
If you default on your secured debts, you will most likely lose your collateral either for a limited time until you pay up or permanently if you fail to pay the amount in the time that the creditor asks.
Secured debts are seen as more important as there is collateral that you might lose. 4
When Can The Lender Garnish My Wages? Secured v. Unsecured Debts
How To Pay Off Unsecured & Secured Debts?
Making minimum monthly payments towards your loan, be it secured or unsecured, is very important as both can have severe negative consequences.
If you are struggling to make your monthly payments towards your unsecured or secured loans, then here’s how you can pay them off easily.
Avalanche Method
This method involves making more payments towards the high-interest loan first. Make a list of all the debts you owe in order ascending order of interest rate.
Make minimum monthly payments towards all the loans except the one on top with the highest interest rate.
Put all the remaining money towards the highest interest rate loan- the goal is to make the maximum payment towards this loan to pay it off quickly.
Once you are done repaying this loan, repeat the process until all your debts are repaid.
How does this method help?
By making maximum payments towards a high-interest loan, you are paying it quickly, which will help you in saving on interest over the long term.
Snowball Method
This is the exact opposite of the Avalanch method. For this method, make a list of all the unsecured and secured debts that you owe and arrange them from lowest to highest on the basis of how much you owe.
Make small minimum payments towards all except the one on top. Make a maximum payment towards the loan top on the list. Repeat the process when done.
In this, what you are doing is that you are prioritizing repaying your smallest debt first. Because you will be making the maximum payment in this one, the loan will be repaid quickly.
How does this method help?
This method gives you the motivation to keep going. When you repay your smallest debt first successfully, you are filled with a positive sense of repaying the rest of them too.
The Verdict
As a result, it is fundamentally important to understand the biggest difference between unsecured vs. secured debts, and you have to know which one to pay off first in case you can’t pay both of them at the same time.
Unsecured debts are easier to get but have higher rates, and secured debts are harder to get with a lower interest rate.
Secured debts also have collateral backing them up to seize in case you default on your loan payments. Both are important, but you need to decide what you can afford to lose.
Read: Difference Between Debt Settlement And Debt Consolidation
FAQ’s
Are car loans secured or unsecured?
Mostly, car loans are secure. However, there is a possibility for you to find an unsecured car loan too.
Secured car loans are much better deals as you get to save a lot on interest and get to take advantage of promotional financing too. 5
How will I know if my debt is unsecured?
If you take up a loan with a promise to pay them the money in a set period without pledging on your personal property as collateral, then that is an unsecured debt.
What is better- secured or unsecured loan?
Both secured and unsecured come with their issues. If you take an unsecured loan, you will have to bear a comparatively high-interest rate, but you do not risk losing your collateral.
However, if you choose a secured loan, you risk losing your collateral in the event of non-payment of the debt. But the interest rate is less on a secured loan.
So now, which one of the two is better entirely depends on what you are willing to risk. 6
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.
ARTICLE SOURCES
The National Planning Cycles is committed to producing high-quality content that follows industry standards. We do this by using primary sources, such as white papers and government data alongside original reporting from reputable publishers that were appropriate for the accuracy of information while still being unbiased. We have an editorial policy that includes verifiable facts with due credit given where applicable.
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