When taking out a loan for an expensive purchase or just keeping up with your budget, it’s essential to understand how secured and unsecured debt work. Knowing this distinction can help prioritize your repayment strategy and enable better financial decisions.
Secured debts are debts that are secured by something of value, usually an asset. Examples include home loans and auto loans.
Collateral
Collateral is an asset that a borrower pledges in exchange for security on secured debt. This could include a home, car or other tangible property.
Lenders use collateral to determine how much secured debt they are willing to issue to a borrower, and it also serves as security should the borrower default on their payments.
Many entrepreneurs utilize their homes as collateral to secure capital for start-ups or business expansion. These loans tend to be more cost effective and offer more flexible terms than traditional business loans.
Interest Rates
Interest rates are an important factor when comparing secured and unsecured debt. Secured debt carries less risk for lenders, allowing them to offer larger loan amounts with more favorable repayment terms.
Unsecured debt, on the other hand, presents greater risks for lenders since there’s no collateral that can be used as security if a borrower defaults on their loan.
Due to this, lenders often charge higher interest rates for unsecured loans such as credit cards or student loans.
Selecting the appropriate type of debt for your financial situation is paramount. Understanding secured and unsecured debt can help you make an informed decision that suits your unique requirements, helping you reach your financial objectives.
Payments
Lenders who approve secured debt may require you to provide them with an asset (like your home, vehicle or savings account) in case of default on payments. Examples of secured debt include mortgages, car loans and home equity lines of credit.
Secured debt typically offers lower interest rates than unsecured loans and higher borrowing limits, making it a desirable option if you need to consolidate multiple debts or borrow an extensive amount of money.
Unsecured debt on the other hand does not require any collateral. Lenders simply look at your credit score and repayment history when deciding whether or not to extend financing to you.
Unsecured debt products often offer an easy application process and quick funding times, but may carry higher interest rates than secured loans and/or less favorable loan terms. Examples of unsecured debt include credit cards, personal loans and student loans.
Payment Prioritization
When taking out debt, the type of loan you take out – secured or unsecured – can affect your interest rates and loan terms. Secured loans usually offer lower interest rates and longer payoff periods than their unsecured counterparts.
Unsecured debts refer to any obligations that are not secured by collateral such as your home or car. Examples include credit cards, medical bills, most personal loans and student loans*.
In some cases, you might need to prioritize your payments in order to make the most of your money. For instance, if you have both a mortgage and car loan, make sure that both payments are made promptly.
If you don’t have enough money to make both of your payments, renegotiating your debts with a secured lender might be worth exploring. Doing this may help keep your home or car and also boost your credit score.
