Differences Between Secured and Unsecured Debt
Written by Kasey Ng   


A secured debt is a type of debt in which a creditor has been granted a portion of the bundle of rights to specified property. A mortgage loan is a typical example of secured debt. If a homeowner for some reason defaults the mortgage, the ownership of the property will switch to the debt holder. Purchases that will require a secured loan would include a boat, automobile, house, second on a house, land, etc.

In contrast, an unsecured debt is a type of debt that's not tied to any piece of property or real estate. Credit cards are typical examples of unsecured debt. When you apply for a credit card, you do not need to put up any collateral like you would a house for a mortgage loan.

Because of the different nature of these two types of debts, debt holders charge different interest rate for these two types of debts. Generally, debt holders will charge higher interest rate for unsecured loans than secured loans based on the following reasons:
  • Default Risk – When the debtor defaults on an unsecured loan, the creditor will lose everything. In contrast, the creditor of a secured loan will at the very least get the collateral, for example the property for mortgage loan.
     
  • Monthly Payment Risk – Since debtors collateral their assets to obtain the loans, it is more likely that they will keep up with their monthly payment. The opposite is true for unsecured loan because they do not need to give up any assets even if they default.
The difference between the two types of debts is applicable when someone is filing for bankruptcy also. Most unsecured debts can be eliminated under chapter 7 bankruptcy, while secured debts may have to be sold to pay off the debts before filing bankruptcy. 

If you are having a difficult time paying all of your bills, secured debt should always be paid first since it is much easier for a lender to foreclose on your home or car then it is for them to come after you and take your assets to pay unsecured debt.



 
Last Updated on Friday, 24 December 2010 06:11