When it comes to borrowing money, it’s important to know the differences between unsecured vs secured debt and what this means for you.
Unsecured vs secured debt
Very simply, there are two types of debt: secured and unsecured. A secured debt has an asset, such as a house or car, attached as collateral. An unsecured debt does not require collateral.
What is secured debt?
Secured debt is attached to an item of value that you own. If you default on your payments with a secured loan, the lender has the right to repossess the collateral to recoup the money owed.
If you’re looking for a secured loan, you’ll be required to offer an asset to secure the loan. This could be a property, a car, or another item of value.
Secured debt examples
Mortgages, home equity loans and car loans are common examples of secured debts. Some debt consolidation loans can also be secured. If you fail to make your loan payments, the lender can foreclose or repossess your home or car.
What is unsecured debt?
Unsecured debt is money borrowed that doesn’t require collateral. Lenders offer unsecured loans based on creditworthiness through your credit score and credit report, allowing the lender to see if you’ve borrowed money and repaid it in the past.
Unsecured debt examples
Some examples of unsecured debts include credit cards, personal loans, payday loans, utility bills, taxes and student loan debts.
Are student loans unsecured debt?
While a student loan is an unsecured debt (as it’s given without collateral), certain laws govern student loan discharge in the event of filing for bankruptcy or a consumer proposal.
What’s better: a secured or unsecured loan?
There are important differences between a secured and an unsecured loan.
Secured loan pros and cons
Pros
- It’s often easier to get a secured loan as lenders can repossess the collateral if you don’t pay.
- Thanks to lower interest rates, a secured loan can cost less.
Cons
- The lender can sell the asset attached to the loan if you fail to make payments.
- A secured loan often has much higher interest rates, making them more expensive. As a result, they can take longer to complete.
- Secured loans are less flexible as they are tied to an asset.
Unsecured loan pros and cons
Pros
- An unsecured loan comes in many forms and is widely accessible.
- The application process is usually quicker than for a secured loan.
- If you default on payments for an unsecured loan, the lender has no legal right to collateral.
Cons
- Lenders can still take legal action to secure a judgment in court, allowing them to garnish your wages, seize assets or put a lien on a house or car.
- Lenders can also charge off your account and assign a debt collection agency to collect what’s owed.
- An unsecured loan will likely have a lower credit limit than a secured loan, as you are not offering collateral.
- Because unsecured loans don’t require collateral, lenders will typically perform a credit check to decide whether to approve your application. They may also consider other factors, such as your income and employment.
Secured and unsecured loans: how do they affect my credit score?
Lenders of both secured and unsecured loans report your payment activity to credit bureaus. This information is recorded in your credit report, which affects your credit score.
Wrapping up
It’s crucial to understand the differences between unsecured and secured debt before deciding on a loan. There are advantages and disadvantages to each, so carefully review the pros and cons to ensure you choose a suitable loan.
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