Secured Debt vs. Unsecured Debt: Key Differences and Similarities

One of the most powerful steps you can take toward mastering your money is boosting your financial know-how. The more you understand how your finances work, the better equipped you will be to set and reach your financial goals.

When it comes to understanding debt, a key topic to tackle is the differences (and similarities) between unsecured and secured debt. Each type of debt has its place, and knowing when and where to use them is a valuable financial skill.

Secured debts are debts that are backed by some type of collateral, or security. Think of car loans and mortgages that use the vehicle or home as financial security for the loan.

Unsecured debts are the opposite: they're debts without security, so they require no collateral. This could be your credit card or personal loan.

Whether you need collateral is the biggest difference between the two, but it's not the only one. While both types of debt have similar impacts on your credit and finances, the type of debt you have will determine your debt relief options should you need them.

Let's take a deeper look at the two types of debt, how they work, and how they influence your options if you need debt relief.

What Is Secured Debt?

A secured debt is a type of debt that is backed by a valuable asset. That asset is typically referred to as collateral. It may also be called security, as in putting down a security deposit. That's why we call it secured debt.

The type of collateral you need for a secured debt will depend on the type of debt. For example, an auto loan is typically secured by the vehicle itself. A mortgage loan is secured by the property you're buying. 

What happens if you default on a secured debt?

Stopping payments on any kind of debt will have negative impacts on your credit. Beyond that, defaulting on secured debt means you also forfeit your collateral. If you default on a secured debt, the lender can take your collateral and sell it to get its money back.

So, if you have a mortgage loan backed by your home and you stop making payments, the mortgage lender can foreclose on your home. The lender can then sell the property to get back its money. 

Even if your collateral sells for more than you owe, you don't get any of the money. The lender can keep any profits it makes by selling your collateral.

What Is Unsecured Debt?

Unsecured debt is any debt that is not backed by collateral, meaning you put nothing down and pledge no assets to cover the debt. If your debt didn't require a deposit or any other type of security, then it is unsecured.

Most personal loans are unsecured debt. You sign up for the loan, receive the money, then repay it each month, no deposit required. Credit cards are another common example of unsecured debt.

What happens if you default on unsecured debt?

As with secured debt, if you stop making payments on unsecured debt your credit will be negatively impacted. What happens after that will depend a lot on you and the lender.

Typically, the lender will contact you and try to get you to make payments. If that fails, the lender will eventually sell your debt to a debt collection company. The debt collector will then make attempts to contact you for payment.

If the debt remains unpaid, the debt collector may choose to take you to court. If the court finds in the debt collector's favor, it could order your wages to be garnished to repay the debt.

Key Differences Between Secured and Unsecured Debt

Here's a simple breakdown of the differences between the two types of debt.

Overall, secured debt is considered to be better for the lender. The collateral you provide means the lender has less risk of losing its money, since it can sell the collateral if you default on the debt.

Since secured loans are lower risk, they can have less strict credit score requirements and lower interest rates. They are also typically for larger amounts and can have much longer repayment periods.

Unsecured debts are much riskier for the lender since there is no easy way to get their money back if you stop making payments. As a result, unsecured debts can have more strict requirements, much higher interest rates, and offer lower loan amounts.

How Secured and Unsecured Debt Impact Your Debt Relief Options

The type of debt you have will directly impact how you can find relief when you need it. Let's take a look at common debt relief options and how the type of debt you have impacts your choices.

Debt consolidation and refinancing

A popular tool for tackling debt is consolidation and refinancing. This involves getting a new loan to pay off existing debts, such as consolidating multiple credit card debts into one new loan.

Secured debt: You can typically refinance secured debt, such as refinancing a mortgage when rates go down to get a lower interest rate and reduce your monthly mortgage payment. Refinancing secured debt isn't quick, however; it can take months to refinance a mortgage.

Unsecured debt: It's much easier to consolidate and refinance unsecured debt. It can also be a good tool for simplifying your debt if you have multiple unsecured debts and consolidate them into one new loan.

Bankruptcy

Most people looking for debt relief will want to choose Chapter 7 bankruptcy, as this is the type that can discharge, or get rid of, some or all of your debts. However, the type of debt you have will be a big factor in which type of bankruptcy you can use.

Secured debt: You can't typically discharge secured debt during Chapter 7 bankruptcy. Some secured debts can be restructured in Chapter 13 bankruptcy, but this doesn't get rid of them. Chapter 13 may be an option if you want to stop foreclosure on your home and you can get caught up on your mortgage payments.

Unsecured debt: Most unsecured debts can be eligible for discharge during Chapter 7 bankruptcy. This can get rid of the debt for good if you qualify.

Debt settlement

Debt settlement is the process of negotiating with your creditors to get rid of your debt for less than you owe. The type of debt you have will determine if debt settlement is an option.

Secured debt: Your secured debts are generally not eligible for debt settlement. Be wary of any debt settlement company that promises to get rid of secured debts.

Unsecured debt: Many types of unsecured debt could be gotten rid of through debt settlement. You can attempt settlement of your unsecured debts on your own or hire a professional debt settlement company to work on your behalf. Using debt settlement to get rid of unsecured debts could free up money to focus on paying down your secured debts that aren't eligible.

The main factor here is that lenders are far more likely to be open to negotiation for unsecured debts since there is no collateral to back up the debt. Debt settlement could be a better alternative than debt collection or lawsuits for both parties.

Examples of Secured Debts

Here are a few common types of secured debt you may encounter:

• Home mortgages: These loans are backed, or secured, by the property you're buying. You can't usually get a mortgage loan that is larger than the value of the property securing it.

• Home equity loans or credit lines (HELOC): Also sometimes called a second mortgage, these use your home's equity—the value of your home beyond what you owe—as the collateral. If you default on a HELOC, you can lose your home.

• Auto loans: An auto loan is used to buy a new or used vehicle and is backed, or secured, by that vehicle. The size of the auto loan will be based on the value of the vehicle. If you default on an auto loan, the vehicle can be repossessed and sold by the lender.

• Title loans: A title loan is a loan that uses a vehicle you already own and have paid off as the collateral. Defaulting on a title loan will forfeit the vehicle.

• Secured credit cards: A secured credit card is much like a regular credit card, except the credit limit is set based on the size of the cash deposit you make. You can get the deposit back if you close the credit card account with a $0 balance, but you could lose the deposit if you stop making payments.

Common Types of Unsecured Debt

Any type of debt that doesn't require a deposit or collateral is unsecured. Here are a few common examples:

• Unsecured credit cards: If your credit card didn't require a deposit to open, it's unsecured. Store credit cards are also typically unsecured. Credit cards are one of the most common types of unsecured debt. They also tend to have the highest interest rates.

• Personal loans and signature loans: A personal loan you get with just a signature, meaning no deposit or collateral, is unsecured. The lender uses your creditworthiness and income to determine your risk category and to set loan amounts and interest rates.

• Post-paid utilities and services: While not usually thought of as debt, post-paid utilities and services—things you pay for after you receive the service, like a post-paid cell phone bill—are still a type of debt. If you don't make your payments, these can be reported to the credit bureaus as in default and can hurt your credit scores.

Which Debt Should You Prioritize When Money is Tight?

When the budget gets tight and money is limited, it's important to know which debts to prioritize. In most cases, this means putting your secured debt payments first.

Secured debts are often backed by vital assets, like your home and vehicle. Falling behind on secured debts can mean losing your transportation or place to live, which can have widespread consequences. 

Prioritize making at least your minimum payments on all of your secured debts first. This will help ensure you don't lose your collateral. Then you can focus on making minimum payments on your unsecured debts.

Once you can comfortably manage all of your minimum debt payments, any extra money you have to spend on debt should go to your most expensive debts. Typically, this will mean high-interest unsecured debt like credit cards and personal loans.

Debt Relief Options for Unsecured Debt

If your unsecured debts become unmanageable, it may be time to seek out another solution or professional assistance. Here are some common options for unsecured debt relief:

• Debt consolidation: This is when you use new debt to pay off multiple existing debts. Debt consolidation works best when you can get a lower interest rate on the new loan than you are currently paying, as this can reduce your monthly debt payment.

• Debt management plans (DMP): Offered by credit counseling agencies, this is a structured debt repayment plan that uses consolidation and creditor negotiation to hopefully reduce your monthly payment. Debt management plans work best for people who can afford their debts but need guidance for  repaying them.

• Debt settlement: This involves negotiating with your creditors to get rid of your debt for less than you owe. You can attempt debt settlement on your own or hire a professional debt settlement company.

• Bankruptcy: Chapter 7 bankruptcy can get rid of your unsecured debt if you qualify. Chapter 13 bankruptcy can help you restructure your debt and may help you avoid foreclosure.