What is unsecured debt?
Unsecured debt or an unsecured loan refers to a loan not backed by collateral. Because unsecured debt is riskier than secured debt, in which collateral protects against loss, the interest rate is normally higher.
Secured debt, like a mortgage or auto loan, is considered less risky than unsecured debt. If you fail to make payments on a secured loan, the lender can repossess the collateral and recoup some or all of their losses. If a homeowner stops making mortgage payments, the bank will repossess the home, sell it, and recover as much of the debt as possible.
When you are granted unsecured credit, there is no collateral backing the loan. There is more risk for the lender because there is no underlying asset to repossess and sell if the debtor stops paying and defaults. Consequently, lenders charge higher interest rates on unsecured debt than on secured debt.
If you stop making payments on unsecured debt, the creditor has three options: contact you in an attempt to collect, report the delinquent debt to a credit reporting agency, or file a lawsuit. One way a creditor can collect on an unsecured debt once it wins a court judgment is to garnish your wages and bank accounts.
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Unsecured debt example
Nearly everyone takes on unsecured debt: all credit card lending is unsecured debt. That includes cards issued by department stores and gas stations. Student loans are another very common form of unsecured debt — if you default on a student loan, lenders can’t repossess your degree. Other forms of unsecured debt include medical debt, personal loans obtained from a bank or credit union, and loans from friends and family.
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