What is unsecured debt?
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If you have a student loan, a medical bill, a credit card, or a personal loan, you have unsecured debt.
Unsecured debt is any debt that does not have collateral backing. Unlike a home mortgage or a car loan, where the property could be repossessed upon failure to make payments, there is nothing attached to unsecured debt. Put simply, 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. You’ll qualify for the best rates if your credit is good to excellent.
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.
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.
|Unsecured Debt||Secured Debt|
|Medical bills||Home equity loan|
|Credit cards||Auto loan|
|Personal loans||Secured line of credit|
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|
Examples of unsecured debt
Some common forms of unsecured debt are credit cards, student loans and personal loans. If you default on your student loan, your property won’t be taken — nothing has been put up as collateral.
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 obtain loans successfully 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 assets at risk. Laws vary from state to state regarding what personal assets would be exempt from seizure.
How to get rid of unsecured debt
In dealing with unsecured debt, there are two primary options: pay off the debt or file for bankruptcy.
To pay off the debt, there are several potential paths to take. If it is possible for you to reduce your expenses elsewhere, you can shift your finances to pay down the debt faster by dedicating more of your expendable or unassigned income toward eliminating the debt. If that isn’t financially viable, though, you may need to refinance your unsecured debt. This can be done by contacting your lender and establishing new terms for the loan that lower your monthly payments or interest rate.
You can also seek a debt consolidation loan to replace old debt with new debt, typically at a lower interest rate. However, these loans are not always beneficial to you and may have an adverse effect on your credit because they will close multiple accounts while creating new debt.
If paying back the debt is not an option for you due to financial troubles, you may need to consider filing for bankruptcy. There are multiple options for bankruptcy, including Chapter 7 and Chapter 13, which you will have to choose based on your financial situation.
If you file for Chapter 7 bankruptcy, your unsecured debt will largely be wiped out in several months — though your credit score will take a significant hit and your bankruptcy will remain with you on your credit score for up to 10 years. If you file for Chapter 13 bankruptcy, you will agree to pay a portion of your outstanding debt over a three- to five-year period, at which point the remaining debt will be discharged.
It’s worth noting that if you do file for bankruptcy, it is unlikely that student loans will be forgiven.
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.