You may have heard the term unsecured debt and wondered what exactly does that mean? When you borrow money without providing something like your house or car as collateral, that’s called unsecured debt. In other words, the debt is not “secured” by an asset. While there are many types of unsecured debt, the most common include credit card debt, medical debt, some student loans, and payday loans.
If you fail to pay secured debt, the creditor can take the asset you used to secure the debt in return. But if you fail to pay unsecured debt, creditors may take different action to get repaid. Lenders may call you, write you, and they may even sue you and/or request that a court garnish your wages until you pay your debt. Of course, your credit score will probably take a hit as well.
Below, we’ll dive deeper into the question “what is unsecured debt?” and discuss the differences between unsecured debt and secured debt. In addition, we’ll look at whether unsecured debt is good or bad, and how to reduce your overall debt burden to help keep your finances healthy for your future.
Unsecured debt vs. secured debt
Unsecured debt is only one type of debt; the other common kind of debt is called “secured debt”. While both are considered financial obligations, there are a few key differences between them.
|Unsecured Debt||Secured Debt|
|Examples||Credit card debt, payday loans, some personal loans, medical debt, some types of student loans||Mortgages, car or boat loans. Any debt that is backed by an asset.|
|What Happens If You Default?||Since unsecured debt is not backed by any assets, lenders may contact you, sell the debt to a debt collector, or sue you for the amount owed.||Lenders have the right to take your asset. This may mean they foreclose your house or repossess your car.|
Is unsecured debt good or bad?
There really is no good or bad to unsecured debt, but since it isn’t backed by an asset, it’s often considered by lenders to be a more risky investment. Therefore, credit cards, payday loans, and other unsecured loans typically come with higher interest rates and shorter payoff terms. This could cost you thousands of extra dollars and potentially steer you into a cycle of debt if you can’t make your monthly payments. The average interest rates of various types of unsecured debt include:
- Credit card debt: 15.97%
- Personal loans: up to 36%
- Payday loans: 391%
Since it is linked to an asset, secured debt can pose less of a risk for lenders. That’s why mortgages and car loans usually feature lower interest rates and longer payoff terms. The caveat with secured debt, however, is that it can put your valuable assets on the line. If you’re unable to repay it, you may be left without a house, car, boat, or other major asset.
Unsecured debt, along with secured debt, isn’t always bad. It can, however, become a threat to your financial health when you have too much of it, or unable to repay it. Ideally, your debt to income ratio (your monthly debt payments divided by your gross monthly income) should be no more than 30%.
Before you take on new debt, make sure it fits in your budget and you feel confident you can pay it back. If not, you are putting yourself in a difficult financial situation.
How to reduce your debt burden
Now that you know the answer to “What is unsecured debt,” and understand that too much of it can be detrimental, let’s talk about how you can reduce your debt burden. While there are plenty of ways to do so, here are some good options.
- Increase your monthly payments: If you pay more than the minimum payment on your debts, you’ll be able to save on interest and expedite the loan payoff process. For extra money to do so, pick up a side gig or sell unwanted items.
- Build an emergency fund: With an emergency fund, you’ll have cash on hand to pay for unexpected expenses. This can prevent you from taking on more debt. Ideally, you’d save three to six months’ worth of expenses.
- Design (and stick to!) a bare-bones budget: With a bare-bones budget, you’ll be able to cut your expenses as much as possible and put more of your money toward debt. To create one, look at your spending on a month-to-month basis. Then, slash all non-essential expenses like dining out and cable.
- Consider a balance transfer: If interest rates on your credit cards are high, a balance transfer may be a good option. A balance transfer can allow you to transfer your credit card debt to a new credit card with a 0% or low interest rate. It’s an effective way to save money on interest, as long as you can pay off all or most of your debt when the promotional period (usually between 12 to 21 months) comes to an end.
- Ditch expensive habits: It’s fine to treat yourself every once in a while, but pricey habits like daily coffee runs or lunches out can keep you from paying off your debt. Try to drop these habits until you’ve significantly reduced your debt burden.
Struggling with unsecured debt? We could help.
If you’re overwhelmed with unsecured debt and looking for a solution, a debt relief program may be right for you. To learn more, talk to a Freedom Debt Relief Certified Debt Consultant today. They’ll dive deeper into the answer to “What is unsecured debt” and help you find out if you qualify. In addition, they may provide information on other options you can use to resolve debt and build a stronger financial future. Get started now.
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