Introduction

Borrowing money and promising to pay it back with some added interest is known as debt. Many households, as well as businesses and governments, rely on debt as a financial tool. Companies and governments issue bonds and other fixed-income securities to fund expenses, capital improvements, and other initiatives. Households borrow money in the form of mortgages, auto loans, student loans, credit cards, and personal loans to pretty much finance every aspect of life. These debts fall into two parts: secured and unsecured debt.

What is Secured Debt?

Secured debt is debt associated with an asset, such as a car or house. In the event you fail to make payments or default on the loan or debt, the creditor can seize the asset in lieu of opening up a debt collection on your record or taking you to court for payments.

Consensual loans: In such cases, you agree to use your property as a guarantee or collateral. This is a very common type of secured debt. Now, nonconsensual loans have various types too.

Some examples of nonconsensual debts are a money judgment filed against you by a creditor and a tax lien placed against your property because you did not pay federal, state, or local taxes.

Some secured debts are:

• Auto Loans: A loan product specifically used to finance both new and old automobile purchases.

• Mortgages: A loan that can be availed for the sake of buying a real estate, whether in the form of a vacation home or primary residence.

• Home equity line of credit (HELOCs): With a HELOC, you can borrow money out of your home. At the closing, you’re tapping into a pool of cash that you can use during the draw period, which is usually 10 years. Interest rates for HELOCs are almost always variable, although many lenders have introduced fixed-rate products recently.

• Home equity loans: Similar to a HELOC, it allows you to tap into a portion of the equity in your home to get the money. It differs because this money is received at one time, instead of being allowed on demand. The interest rate of a home equity loan is fixed.

• Secured credit cards: They work like regular credit cards. However, prior to acceptance of the card you will typically be required to make a deposit that is usually in the same amount as the credit line. So, if the minimum payment on your credit card is not made, the issuer of the credit card has a right to draw out from the security deposit the amount they are owed.

With secured debt, you generally receive a better interest rate because if you do not pay back the loan, the bank can take back the collateral and sell it to recoup its losses. Creditors will also be more lenient with terms because the loan is secured by the asset and there is less risk to the bank.

What is Unsecured Debt?

Unsecured debt carries no collateral backing: No security is required; again, the name in itself says so. If this type of debt were to be defaulted by the borrower, the creditor needs to file a lawsuit to collect what it is owed. 

Some unsecured debts are:

• Credit cards: This is a type of revolving debt and is spent according to how one accumulates use. And no limit for the expenditure of the money, but then again, the interest rates are somehow higher compared to other types of unsecured debt.

• Personal Loans: These carry fixed interest rates and terms of repayment and can usually be used to finance any activity. However, some will not allow the use of the proceeds for business or college tuition expenses.

• Medical loans: It is a personal loan, used to cater for medical treatments and other medical procedures.

• Student loans: Either federal or private loans, and they are only for higher education purposes, such as college tuition and room and board, books, etc. 

Most unsecured debt products have an easy application and relatively fast disbursement time. Besides, this credit has always been attractive because it does not require the pledging of any asset for approval purposes.

However, there are some drawbacks to consider. Such debt products normally have a higher interest rate associated with them because they are riskier for the lender. Furthermore, the lender or creditor will most likely ask you to have good or excellent credit to qualify for competitive financing.

Secured Debt vs. Unsecured Debt

Conclusion

In conclusion, secured debts are those for which the borrower puts up some asset to serve as collateral for the loan. Secured loans reduce the level of risk involved for lenders.

Unsecured debt does not have some asset or value backing it. Lenders advance their funds based on the borrower’s creditworthiness only in an unsecured loan with promises to repay. Since such debt poses relatively lesser risk, secured debt attracts a relatively lower rate of interest. 

Secured and unsecured debt or obligations both hold a promise to pay, but one conveys a good deal more punitive sanctions if that promise isn’t fulfilled. One might be able to get more credit by using secured credit, and the cost may also be lower too. But unsecured credit also has some advantage too.