Unsecured debt is a type of debt that does not use collateral to secure the loan. Things like car loans and mortgages are considered secured debt, since the car or home could be repossessed if you don’t pay back the loan. Personal loans, on the other hand, are often considered unsecured debt, because they don’t have that same risk.
What is unsecured debt?
Unsecured debt is any debt that does not have collateral backing — in other words, a lender cannot repossess or foreclose on an asset you own. Since the debt does not have an asset attached to it, it’s riskier for the lender. To compensate for this risk, lenders usually charge higher interest rates.
The interest rate charged on your unsecured debt is based on your creditworthiness. If your credit is good to excellent, you’ll qualify for the best rates.
Taking on this form of debt is common. As long as you know how to manage your debt properly, you can use unsecured debt to secure your financial future.
Examples of unsecured debt
Although lenders typically charge higher interest rates on unsecured debt, there are ways to get around this. For instance, you may be able to qualify for an introductory rate of 0 percent on a credit card. Another way to bypass the higher interest rates would be to pay your credit card bill in full each month.
What happens if you don’t pay an unsecured debt?
Although a lender can’t initially take your assets for not paying an unsecured debt, you’ll face other consequences. For one, you’ll be charged late fees for paying late. And if you go too long without making a payment, your unsecured debt will be sent to a collection agency.
Once your debt is sent to the collection agency, your credit score will decrease, since payment history accounts for 35 percent of your score. This will make it harder for you to successfully obtain loans in the future.
Depending on what type of unsecured loan you have, your wages might be subject to garnishment if you fail to repay your debt. A creditor might also sue you in court and place a lien against your property. If a court awards a judgment to the lender, this could put your personal assets at risk. Laws vary from state to state as to what personal assets would be exempt from seizure.
Unsecured debt vs. secured debt
Unlike unsecured debt, secured debt has an asset attached to it. Two of the most common forms of secured debt are mortgages and auto loans. If you don’t pay those debts, a lender can foreclose on your home or repossess your vehicle.
Since secured loans have assets attached to them, lenders typically charge lower interest rates. For example, while they’re similar products in terms of loan amounts and repayment terms, secured home equity loans have an average rate of 5.78 percent, while unsecured personal loans have an average rate of 11.88 percent.
However, both secured and unsecured debt impact your credit. If you miss a payment, this may be reported to the three major credit bureaus: TransUnion, Experian and Equifax.
|Unsecured Debt||Secured Debt|
|Interest rate||Typically higher||Typically lower|
|Consequences of defaulting||Lower credit score||Lower credit score and repossession of asset attached|
|Given a title after repaying loan||No||Yes|
How to get rid of unsecured debt
To eliminate unsecured debt, you essentially have two options: pay it off or file for bankruptcy.
If you’re looking to get rid of unsecured debt quicker, you can do so by cutting expenses and reallocating the money saved toward eliminating your debt. You could also look into refinancing your unsecured debt to get a lower interest rate or lower monthly payments.
However, if you are facing extreme financial difficulty or your credit score isn’t good, those two options might not be the right move for you. In that case, you might consider filing for bankruptcy.
Filing for bankruptcy will allow you to get rid of some unsecured debt like credit card debt, payday loans and personal loans. For student loans, you must prove that repayment would cause undue hardship in order to receive a discharge.
The bottom line
With unsecured loans, your assets are not at risk of being seized unless the court awards a judgment to the lender. However, it is still important to understand the consequences of not paying your unsecured debt. To avoid late fees and serious harm to your credit score, create a plan to pay off your unsecured debt before applying.