Many people don’t realize it, but not all debts are the same. There are two basic types of debt – secured debt and unsecured debt. At the most basic level, the difference between the two is that one type of debt is tied to a piece of property while the other type is not.
Secured debt
Secured debt is debt that is "secured" by an asset. The asset is used as collateral for the debt and can be seized by the lender if you default on the terms. Common types of secured debt are mortgage loans, which are secured by houses, and auto loans, which are secured by cars. If you fall behind on your mortgage or auto loan payments, your lender can foreclose on your home or repossess your car.
Unsecured debt
Unsecured debt is the opposite of secured debt. It’s debt that isn’t secured by an asset. With an unsecured loan, the lender’s only guarantee of loan repayment is your signature on the loan agreement. Most credit cards are a type of unsecured debt.
If you fall behind on unsecured loan payments, the lender has fewer choices for recourse. It can report your delinquent payments to the credit bureaus, thereby damaging your credit record. It can also turn your debt over to a debt collector or sue you for the amount owed. But there is no collateral that can be automatically seized to cover any of the loan losses.
Is one better than the other?
Secured and unsecured debts have different purposes, so it’s nearly impossible to say that one is better than the other. Because there is no collateral associated with unsecured debt, lenders rely on your credit history to approve you for an unsecured loan. If you have a poor credit history, you’ll have a hard time qualifying for an unsecured loan. If you are approved, you’ll likely have a higher interest rate than a secured loan for the same amount. Not only that, unsecured loan amounts are typically limited. Many lenders will lend up to $25,000 on an unsecured loan.
In some ways, an unsecured loan is more attractive since the lender can’t (easily) take your property if you fall behind on your loan payments. On the other hand, when you default on a secured loan, you’ll lose the property, get a bad credit rating, and could even end up owing the lender a deficiency judgment. A deficiency judgment is the difference between the amount you owed on your loan and the amount your lender recovered from your repossessed asset.
Secured and unsecured credit cards
When it comes to credit cards, there are secured and unsecured versions. Unsecured credit cards are more prevalent. In fact, many people don’t know there’s such a thing as a secured credit card. Secured credit cards, which require a security deposit to be made against the card’s credit limit, are less common.
A secured credit card is a good option for people who don’t qualify for unsecured credit cards either because they don’t have sufficient credit history or they have a bad credit history. Having a secured credit card can help build a credit and even rebuild a bad credit history because it offers a chance to gain positive credit history. That’s if the secured credit card issuer reports your account to at least one of the three major credit bureaus. So, if you want to use a secured credit card to help rebuild your credit, make sure you get one that will be included on your credit report. Make sure to not carry a balance from month to month on a secured credit card, though, because the interest rates tend to be higher than on an unsecured card.
