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Unsecured Debt vs. Secured Debt: How are They Different?

Find the right kind for you here.

Credit Card debt
Revolving credit can push back your financial aspirations by years if you keep making the monthly minimum payments. Burst/pexels.com

The US household debt has surpassed $14.35 trillion as new loan applications surged during the pandemic. An American holds an average credit card debt above $5,000, whereas 46% of homeowners above 65 had a median mortgage debt of $77,000 in 2016!

Debt is not necessarily bad; you need to know which one you need and how to use it. If you have to take out a loan or swipe your credit card sometime soon, it will help to know the kind of debt you are dealing with, the consequences of defaulting for each, and how to prioritize them.

There are primarily two types of debt: unsecured debt and secured debt—these branch out into subsets like credit cards, personal loans, mortgages, and auto loans. When considering a loan, you'll need to decide between unsecured and secured debt.

What is Secured Debt - and What Happens When You Default

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Secured debt creditors use your property or assets as collateral. Generally, these are long-term high-amount loans like mortgage or auto loans. Maria Orlova/pexels.com

Mortgage and auto loans are some examples of secured debt, where the lender offers the loan with a security interest. The concept is pretty easy to understand.

Think of a typical auto loan: you use money from a lender to buy a new car. The lender helps finance your loan and attaches your vehicle as collateral. However, if you default on your payments, the lender can take possession of your car, sell it, and use the proceeds to clear your debt. Similarly, when you buy a new house, you make monthly mortgage payments. Your mortgage is a secured loan where the collateral is your home, which can be taken away from you if you default.

Why do creditors attach assets as collateral to secured debt? So they can have some confidence in getting their money back without much trouble if you fail to repay. Secured debt gives them peace of mind that they can recover with the security interest.

The upside of secured debt is that you can get access to vast sums of money, which isn't possible with unsecured loans. Simultaneously, a secured loan can save you money with low-interest rates since they are considered less risky than unsecured loans.

Buying a home or a car is a significant life event that should only be done carefully. After all, you don't want to lose these assets due to non-payments. However, if you make timely payments for auto loans or mortgages, you can keep your house or car. When you start defaulting, the lender - as per the agreement - will hold the right to take back your possessions.

As such, it is vital to read your agreement before taking out a secured loan. Most people are eager to take a loan despite being unaware of how soon a foreclosure might happen due to skipped mortgage payments. Late fees may also be incurred within a few days or weeks, while the consequences to your credit score will be the same as missed credit card payments. Keep in mind that when your credit rep takes a hit, it could show up on your credit report for seven years. The worst that could happen is that the proceeds from the sale of your collateral might not even cover the entire debt, leaving you responsible for any pending balance.

What is Unsecured Debt - and What Happens When You Default

debt consolidation
Knowing that ins and outs of your loan process and agreement will help in building your repayment strategy. Oleg Magni/pexels.com

Unsecured loans are usually faster to get, but they also require a strong debt repayment history and high credit score. Common examples of unsecured debt include personal loans, medical bills, credit cards, and student loans. You may use the funds to buy something, pay for doctor visits or college tuition. These loans are considered high-risk for lenders since their only assurance is your word and credit profile. The same reason why they come with high-interest rates and quick reporting to debt collectors if you miss deadlines.

On the contrary, there's no collateral on the line for creditors to take over, with this kind of debt. So, if you fall behind on payments for prolonged periods, the creditor can take you to court for settlement as a last resort. Your credit score will dip. This can negatively affect your future job opportunities, chances of finding a place to live, and getting a loan approved. So, while the legal recourse of unsecured creditors may be more limited than secured debts, there will still be consequences.

Which Debt Should You Prioritize?

Simply put, you will have more to lose with secured debt, and you will need to prioritize your mortgage and auto loans in your repayment strategy. After all, losing your 'shelter' due to missed mortgage payments could prove to be devastating for your family. Even if you buy a home after carefully budgeting your money over the years, for instance, you could still suddenly find yourself drowning in monthly mortgage payments, credit card debt, or auto loans - leading to a money crunch.

Here, prioritizing your mortgage would be the better option; providing shelter is more important. Make sure you pay your monthly mortgage on time while working on a repayment strategy for your unsecured debts.

Which Loan do You Need?

debt-free low credit score
The kind of loan you need completely depends on the purpose. If you are buying a house, you have to take out a mortgage. If it's for shopping, an unsecured credit card would suffice. Andrea Piacquadio/pexels.com

The answer to this question lies in how much money you need to borrow. Also, are you ready to put your assets at risk? Secured loans let you borrow money at low-interest rates but with collateral. So, if you are confident of making timely payments for years, a secured loan might be the best option for you.

If you want to borrow less money for a short term, an unsecured loan would be the way to go. Chances of approval will solely depend on your credit history since 90% of lenders check people's FICO scores before approving loans. These funds can be used for home renovations, online shopping, medical bills, and student loans, among other things.

Sometimes, you won't get to choose the type of loan that you need. For instance, car loans and mortgages are always secured loans. Simultaneously, if you have a low credit score, you can apply for a secured credit card by making some initial deposit.

Choosing a loan can get tricky when you have to remodel your kitchen or have other side projects. Should you go for a home equity line of credit (HELOC) or an unsecured loan for financing the project?

You must compare repayment schedules, interest rates, late fees, and other obligations for both. You must know that HELOC is slightly riskier but will let you borrow precisely what you need, whereas unsecured creditors will loan out a specific amount that you will have to repay even if you don't need the whole thing.

When to Get Help Paying Off Loans

Paying off mortgages, credit card debts, and student loans can be quite tricky. The pandemic has made it difficult for students to repay education loans, whereas millennials are neck-deep in credit card debt with job furloughs on the high. Millions of older workers are also facing extreme stress due to permanent job losses; a different class of tragedy.

Getting stuck in this vicious cycle of loans can be challenging to get out of, too. If you are missing payment deadlines, making monthly minimum payments for years, or straining your budget too hard, it may be time to get professional help.

Sometimes, it is better to get a clean slate rather than delaying your financial aspirations because of exorbitantly high-interest rates. Filing for bankruptcy should be your last resort, and you should consider other solutions first, like debt relief, debt settlement, and counseling for a better outlook.

When seeking professional advice, it would be wise to work with experienced financial advisors, CFAs, and business owners for the best resolution. CuraDebt can be a good start since they have over two decades of experience helping businesses and individuals deal with existing unsecured loans like credit cards debt, personal loans, medical bills, business debt, IRS Debt, and Taxes.

Just like buying a house, it is essential to work with a credible firm so you can get your debt settlement done right. CuraDebt is licensed and compliant with all state and federal laws. They are a recipient of multiple accolades and awards, mostly for low fees, client satisfaction, and best savings.

The new decade calls for new strategies, and getting out of unending debt is a smart thought you must realize.

Check out CuraDebt today!

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