Secured Debts vs Unsecured Debts – What Is The Difference?

It won’t be wrong to define credit score as fluid. Even a minute change in the credit report can affect your credit score, this change can be either up or down. A FICO score keeps a check on your payment history, knows the length of your credit history and the amount of debts you have, and whether you have applied for fresh credit.

You should be aware of that both the secured and unsecured debts get reflected on your credit report and it influences your credit score as well. Before we proceed with the dissimilarities, let us get to know about both secured and unsecured debts –

What Are Secured Debts?

– Also known as liens, this type of debt is protected mainly by a collateral in order to cut down the risk that is involved with the lending like a mortgage. If, as a borrower, you have failed to make a repayment, the bank is authorized to seize your house and they can even sell your house. Just like unsecured debts, the secured debts are also informed to the three credit bureaus.

Secured debt is further divided into voluntary lien and involuntary lien. Let us get in the details of secured debt –

Voluntary lien – It is also termed as a voluntary lien. This takes place when you give your consent of paying money, to the creditor, in exchange for some benefit. The debt is also attached by a collateral, it can also be said that a collateral has secured the debt.

Involuntary lien  – It is, basically, a claim that is being made against the property and there is no involvement of agreement. Even the state enjoys the right to impose this lien. It mainly comprises of –

  • Judgment liens.
  • Real property taxes.
  • Mechanic’s liens.
  • Liens for delinquent income taxes.
  • In some states. landlord liens.

Why secured loans are offered by the banks –

It can prove beneficial for most people as it offers them with an opportunity to have a home loan and along with that it also offers security for the bank. One of the other examples of secured debt is a car loan. When you purchase a car, you will have to sign an agreement that says if you didn’t make the payments (due to any reason) on your car loan, the lender has the authority to take the possession of your car.  

How to judge a secured debt ?

There will be times when you won’t be able to make out whether the debt is secured or unsecured. The main reason is that the security agreements are, most of the times, mentioned in small fonts and most of the times people tend to overlook them while buying an item.

The best way to make out between a secured and unsecured debt is by closely reading the contract documents.

What Are Unsecured Debts?

– There is no requirement for any collateral for these debts. As there is no collateral, it is much riskier for the creditor and this is the reason, as a protective measure, high-interest rate is attached to the loan. Some of the key examples of unsecured debts are – legal bills, personal bank loans, gas cards, medical debts, tax debt, and credit card debts. But prior to exercising this right, the creditor has to file a lawsuit in the court. There he has to prove that the contract is still valid and you have failed to meet the clauses or the points and have a judgment. This means –

  • The loan payment remains the same each month.
  • The time period will be fixed, that is required, to repay the loan.
  • The interest rate also stays the same and cannot be altered during the tenure of the loan.

Well, almost every loan is unsecured in nature, only auto and home loan are two exceptions which are secured.

When unsecured debt is not paid –

If you are not able to make the payment, due to any reason, the creditor will call you to get the payment, he can file a lawsuit, and he can even report to the reporting agency. If he is a nongovernmental unsecured creditor, he is not authorized to seize your assets and for that, he will need a court judgment.

Getting a Court Judgment by the unsecured creditors –

In order to have a judgment, it is important for the creditor that he has filed a complaint in the federal court. The copy of that complaint will also be shared with you. It’s not that the creditor has all the rights, you also have the right to file an answer and contest the lawsuit before the judgment arrives.

Types Of Unsecured Debts

  • Credit cards – Credit card debt is one of the common types of unsecured debts. It has a revolving line of credit nature where you can continue borrowing each month, thus carrying balances over. The best way is to make a payment is to pay more than the minimum each month. If you don’t make timely payments, the interest rate, that is 15.7% on average, can rise considerably to 27% or even higher. The other advantage of paying more than the minimum is that you get to take yourself out of the debt much faster.
  • Personal Loans – Such loans can be used for multiple reasons such as paying for the home repairs or starting up a business. These loans come with a cap and usually, the bank is behind the funding. Original lending terms will entirely depend on your credit history, so your credit history also bear great significance. When you have a good credit score, the interest rate will also be lower and above all, you get to save a significant amount of money.
  • Business Loans – It has been observed that unsecured lines of credit are being used for cash on demand by the majority of the businesses. Let us assume that an unexpected expense comes out from nowhere, especially the one that affects your business heavily, then this is where the bank credit line can prove handy.

Credit lines can be defined as pools of cash that the business owners can use anytime during the dire straits. Make sure you have the holistic knowledge of the credit line and you should also know how quickly you can have the cash access and what are the interest rates as well.

  • Apartment Leases – Well, rent is not deemed as debt, but when you are not able to pay it, you get indebted to your landlord. If such a scenario arises, your landlord can seek a legal action against you to evict you. However, the good part is that you don’t have any of your belongings at risk of being seized but your debt will be considered as unsecured.

Pros & Cons of unsecured debts –

Pros –

  • You don’t have to worry about getting your assets seized.
  • You get to enjoy shorter repayment term.

Cons –

  • The interest rate is on a higher side.
  • It is quite complicated to get it from a lender.
  • You don’t get to enjoy any tax benefits.
  • You will be allotted lower borrowing amount.

Let us get to the important part i.e. difference between the secured debts and unsecured debts, here it is –

Secured Debt –

  • There is involvement of collateral as security in secured debt, such as home mortgage loan or a car loan.
  • If you have become delinquent on the secured loan, your assets will be seized.
  • When it comes to secured debt, you can borrow more money and have better interest rates as well because the lender knows that he has the collateral in case you become delinquent.
  • It is imperative that you have paid your secured debt first. The main reason behind this is that you have your assets at risk if you don’t.

Unsecured Debt –

  • In unsecured debt, there no collateral involved, such as credit cards.
  • If you are not able to make the payments, the lender cannot seize your property or any other asset. However, the lender can make you repay using legal methods like suing you.
  • Lenders charge more interest rates or they can also restrict you amount you can borrow.

So, there you go if you have any doubt regarding secured and unsecured debts, then you can refer the above-discussed information.