Secured vs Unsecured Debt (With Examples!)
Debt generally falls into one of two categories. Secured and unsecured. This is true of loans, credit cards, and other types of debt. But what’s the difference between secured and unsecured debt?
Here, you can learn the definitions of secured and unsecured debt and how each type truly works. We’ll also look at examples of secured and unsecured debt.
Nothing in this should be considered financial advice. Talk to a financial advisor or other expert if you need help making financial decisions.
What Is Debt?
In simplest terms, debt is when one party (the borrower) owes money to another party (the lender). The borrower typically must pay back the amount borrowed plus interest and fees.
People generally take on debt because they need to cover a cost they can’t otherwise afford. What they qualify for – secured vs unsecured debt – depends on many factors. These can include credit score, employment and income, the lender's policies, and more.
The biggest difference between secured and unsecured debt is the need for collateral. Do you have to offer something of value to the lender before they agree to lend you money or give you a credit card?
What is Secured Debt?
Secured debt is backed by collateral. Collateral is an asset (something of financial value) that the lender gets if you don’t pay all of what you owe. Lenders often prefer this arrangement because the risk to them is comparatively low.
Collateral is often based on the specific debt you’re taking on. For instance, if you take out a mortgage, the house you buy is collateral. Secured credit cards require a deposit, and that deposit is your credit limit. Though this may be inconvenient, a secured credit card may help your credit score.
If you pay off a secured loan, the lender no longer has a lien (claim) on the asset, and they can’t take it from you anymore. However, the cash down on a secured credit card is rarely refunded.
Defaulting on secured loan debt means the lender can keep the collateral. The lender may also require money on top of the collateral if the asset is of lower value than what's still owed.
If you default on a secured credit card, the credit card company keeps the deposit. It also charges you for anything you owe beyond that. In either case, your credit score can take a hit.
Secured loans and secured credit cards are often easier to get and have lower interest rates. Lenders consider the collateral to be motivation to pay.
Examples of Secured Debt (and Their Collateral)
Here are some of the more common types of secured debts and their collateral.
Mortgage. The home you buy is the collateral.
Auto loan. The vehicle is the collateral.
Secured personal loans. These are rare because it's hard to tie a personal loan to a logical asset. However, an expensive possession, real estate, a vehicle, or insurance could be personal loan collateral. Stocks, bonds, savings, certificates of deposit, and future paychecks may also be collateral.
Secured credit cards. Collateral is typically a cash deposit equal to the credit limit. For instance, if you want to be able to spend up to $500 on your credit card, you pay a deposit of $500.
What Is Unsecured Debt?
Unsecured debt is not backed by collateral. You’re expected to pay back what you borrowed (plus any interest or fees), period. A lender or credit card company typically checks on a few things before letting you borrow. These factors can include your.
Credit score. This number between 300 and 850 shows how reliably you’ve paid your debts, to how many lenders, and for how long. To get a good score and terms, you likely need a good-to-excellent score.
Income. Lenders want to know you make enough to easily make all your payments.
Debt-to-income ratio (DTI). DTI is your total revolving debt compared to your income; the lower this ratio, the better.
Unsecured debt often has a higher interest rate than secured debt. This is because unsecured debt is risky to the lender. They want to make sure they have the best chance of getting their money back.
If you don’t pay an unsecured debt, your lender may tack on late fees. If you stop paying entirely, they can send your debt to collections. Collections can call you and send you letters to get you to pay; this can be a headache! If that doesn’t work, you could start getting letters from a lawyer. You may even end up at the receiving end of a lawsuit. And, your credit score will take a big hit!
Examples of Unsecured Debt
These are some of the most common types of unsecured debt.
Credit cards. Most credit cards are unsecured.
Personal loans. Since personal loans don’t often have a specific thing to use as collateral (e.g., a car), they’re frequently unsecured.
Medical bills. Since you don’t generally pre-pay medical bills, there wouldn’t be a way to secure this debt.
Student loans. Since your education isn’t tangible, there isn’t a relevant item to secure. All federal student loans and most private student loans are unsecured. A private student loan could require a cosigner (a person who agrees to pay the debt if you don’t).
FAQs About Secured and Unsecured Debt
What is the difference between secured and unsecured debt?
Secured debt requires collateral, and unsecured debt doesn’t.
Secured vs unsecured debt. Which is safer?
Secured debts are usually safer for lenders. Unsecured debts are typically safer for borrowers. If you default on secured debt, the lender doesn’t take a total loss. But if you default on unsecured debt, you aren’t directly risking the asset you put up as collateral. This makes recouping losses hard for the lender.
Do secured loans have lower interest rates?
Secured loans usually have lower interest rates because the lender can take an asset if you don’t pay them back.
What happens if I default on secured debt?
If you default on a secured debt, the lender gets to keep the collateral. They can also charge you extra money if your collateral is worth less than what you owe.
For instance, say you default on an auto loan while owing $13,500, but your car is currently worth $10,000. The bank can seize your vehicle and demand you pay them $3,500. Or suppose you had a $500 deposit on a secured credit card and owed $750 when you stopped paying. Upon default, they can come after you for $250 in addition to keeping the $500. It’s how they get all their money back.
Defaulting on secured debt can also hurt your credit score.
What happens if I default on unsecured debt?
If you don’t default on unsecured debt, your lender will likely send your debt to collections. A collections agency will call you and write you letters asking for payment. Next, if you don’t pay, they’ll get a law firm involved. This could escalate all the way to a debt lawsuit.
Your credit score will take a big hit if you default on an unsecured debt, too.
Can you convert unsecured debt to secured debt?
You may be able to convert unsecured debt to secured debt through debt consolidation. For this, you take out a secured loan to pay off your unsecured debt.
Is a personal loan secured or unsecured?
Personal loans are usually unsecured because there often isn’t logical collateral. Lenders tend to focus on a borrower’s creditworthiness over any assets they can offer.
Is a mortgage a secured loan?
Yes. If you don’t repay, the bank can take the house.
Is a car loan secured debt?
Yes. If you don’t repay, the bank can take your car.
Is credit card debt unsecured?
Credit card debt is usually unsecured, but secured ones exist. Secured credit cards require a deposit, and that deposit is equal to your credit limit.
Are student loans secured or unsecured?
Student loans are generally unsecured. The lender is betting on your education leading to a job that pays well, which will ensure you pay them back. Keep an eye on your credit score during college to help make sure this happens.
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