Secured Debt vs. Unsecured Debt
The primary difference is whether collateral is required to back the debt
Details are important. Especially if you’re researching loans or trying to manage debt. And one major detail to understand is whether debt is secured or unsecured.
The main difference between the two comes down to collateral. Collateral is an asset from the borrower—like a car, a house or a cash deposit—that backs the debt. Secured debts require collateral. Unsecured debts don’t. Those are the basics. But keep reading to dig into even more of those details.
What Is Secured Debt?
When debt is secured, the lender will typically ask you to put up an asset to guarantee the debt. That collateral could take the form of property or cash assets.
Secured credit cards are one form of secured debt. They typically can be used to make purchases the same way as traditional credit cards are used. But they require a security deposit to open. Think of it like a security deposit you pay a landlord before renting an apartment.
Mortgages and auto loans are two other common situations in which you may encounter secured debt. In those cases, the item purchased with the borrowed money—the home or the car—typically serves as collateral.
Secured debts are generally viewed as a lower risk for lenders than are unsecured debts. For example, if a secured debt goes into default, the collateral can be taken by the lender. As a result, these loans may offer better interest rates and financing terms. And lenders may be less strict about qualifying criteria, like credit scores.
What Happens if You Don’t Pay Secured Debts?
Secured debts may come at a lower risk to lenders. But as a borrower, remember that collateral can be taken if the debt isn’t repaid. There may be other consequences too, like fees or penalties for missing payments.
And if the lender reports negative information to credit bureaus, it could affect the borrower’s credit scores.
You can check the terms and conditions of your secured debt to learn more.
What Is Unsecured Debt?
When a debt is unsecured, there’s no collateral attached to it. Unsecured debt can take the form of things like traditional credit cards, personal loans, student loans and medical bills.
Because unsecured debts aren’t backed by collateral, lenders may view them as riskier than secured debts. That means qualifications to be approved could be stricter and interest rates could be higher.
But there could be benefits. Take unsecured credit cards, for example. Lenders don’t require a security deposit. Credit limits may be higher than those of secured credit cards. And cards may come with additional perks, such as rewards miles or cash back. Plus, if you’re able to pay off your balance every month, you may be able to avoid paying interest.
Credit cards are just one example of unsecured debt. Be sure to check with your lender to learn more about how other unsecured debt works.
What Happens if You Don’t Pay Unsecured Debts?
Even without collateral, there are consequences for not repaying your unsecured debt. Every situation is different, but getting behind on payments could result in late fees or extra interest charges. And if payments get too far behind, the account could be sent to collections.
Lenders could report late payments or defaults to the credit bureaus. And that negative information can stay on your credit reports for up to seven years. Without collateral to collect, falling too far behind could result in debts being sent to collections.
Paying Off Secured Debts vs. Unsecured Debts
Whether secured or unsecured, having a plan to pay off debt can be helpful.
It’s important to make at least the minimum payment on all debts as part of any plan. But it could make sense to put more money toward secured debt to ensure you don’t lose collateral—especially if that collateral is a home or a car. If you’re concerned with higher interest rates, it could make sense to prioritize unsecured debts to avoid paying more in the long run.
The Consumer Financial Protection Bureau (CFPB) offers two methods you might consider:
This method involves paying off your smallest debt first. Make a list of all your debts and order them from lowest to highest based on how much you owe. For each debt besides the smallest, make the minimum payment. Then, put additional money in your budget toward the smallest debt. Once you settle it, apply the snowball method to the next smallest debt.
The CFPB refers to it as the “highest interest rate method.” This strategy involves targeting high-interest debt first. Start by making a list of all your debts. Then order them from highest to lowest based on interest rate.
Pay the minimum on each debt besides the one at the top. Then, like with the snowball method, put the remaining money you’ve budgeted toward the debt with the highest interest rate. After you’re done paying it off, apply the avalanche method to the debt with the next highest rate.
Refinancing your debt or using a balance transfer to consolidate or simplify payments could be another option. But be sure to explore the full cost of transferring a balance and interest rates. Things like transfer fees might make consolidation more costly.
Talking to a financial expert before you do anything could help you make the best decision.
Monitoring Your Credit
Whether you have secured or unsecured debt, monitoring your credit can help you see where you stand and what’s being reported to credit bureaus. CreditWise from Capital One can help. It’s free for everyone—not just Capital One customers—and using it won’t hurt your credit.
CreditWise lets you access your TransUnion® credit report and weekly VantageScore® 3.0 credit score. And you can even explore the potential impact of your financial decisions—like paying off debt or adding new lines of credit—before you make them by using the CreditWise Simulator.
You can also get free copies of your credit reports from all three major bureaus—Experian®, Equifax® and TransUnion—by visiting AnnualCreditReport.com.
Debt can seem complicated. But when you dig into the details and learn about repayment strategies, you may find that it’s not quite as intimidating. If you want to continue to learn more, it might be worth exploring the differences between installment loans and revolving credit next.
Government and private relief efforts vary by location and may have changed since this article was published. Consult a financial adviser or the relevant government agencies and private lenders for the most current information.
We hope you found this helpful. Our content is not intended to provide legal, investment or financial advice or to indicate that a particular Capital One product or service is available or right for you. For specific advice about your unique circumstances, consider talking with a qualified professional.
Your CreditWise score is calculated using the TransUnion® VantageScore® 3.0 model, which is one of many credit scoring models. It may not be the same model your lender uses, but it can be one accurate measure of your credit health. The availability of the CreditWise tool depends on our ability to obtain your credit history from TransUnion. Some monitoring and alerts may not be available to you if the information you enter at enrollment does not match the information in your credit file at (or you do not have a file at) one or more consumer reporting agencies.
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