SoFi

Debts fall into two broad categories: secured debt and unsecured debt. Though both types of debt share some similarities, there is one key difference. Secured debt is backed by collateral, and unsecured debt isn’t.

It’s important for borrowers to understand how secured and unsecured debt work. That’s because the type of debt you choose could impact such things as loan terms and interest rate and whether you can get credit. What’s more, knowing the difference between these two types of debt can also be one tool to help you determine the order in which you’ll repay the debt.

What Is Secured Debt?

Secured debts are backed, or secured, by an asset, such as your house. This asset acts as collateral for the debt, and your lender is what is known as the lien holder. If you default on a secured debt, the lien gives your lender the right to seize the asset and sell it to settle your debt.

Mortgages and auto loans are two common types of secured debt. A mortgage loan is secured by the house, and an auto loan is secured by the vehicle. You may also encounter title loans, which allow you to use the title of your vehicle to secure other loans once you own a car outright.

What Are the Possible Benefits of Secured Loans?

Because lenders can seize an asset to pay off the debt, secured loans are considered less risky for the lender than unsecured loans. “Low risk” for a lender can translate into benefits for borrowers. Secured loans generally offer better financing terms, such as lower interest rates.

Secured loans may also be easier for borrowers to qualify for. For example, secured loans may have less stringent requirements for credit score compared to unsecured loans, which generally rely more on the actual credit and income profile of the customer.

What Are the Stakes?

The stakes for borrowers can be pretty high for secured loans. After all, consider what happens if you stop paying these debts. (Timeframes for secured loan default can vary depending upon the type of secured debt and lender terms.) The bank can seize the secured asset, which might be the house you live in or the car you need to drive your kids to school or yourself to work.

Failing to pay your debt, or even paying it late, can possibly have a negative effect on your credit score and your ability to secure future credit, at least in the shorter term.

What Is Unsecured Debt?

Unsecured debt is not backed up by collateral. Lenders do not generally have the right to seize your assets to pay off unsecured debt. Examples of unsecured debt include credit cards, student loans, and some personal loans.

What Are Some Benefits of Unsecured Loans?

Unsecured loans can be less risky for borrowers because failing to pay them off does not usually result in your lender seizing important assets.

Unsecured loans often offer some flexibility, while secured loans can require that you use the money you borrow for very specific purposes, like buying a house or a car. With the exception of student loans, unsecured debt often allows you to use the money you borrow at your discretion.

You can buy whatever you want on a credit card, and you can use personal loans for almost any personal expense, including home renovations, buying a boat, or even paying off other debts.

Recommended: Typical Personal Loan Requirements

What Are the Stakes?

Though unsecured loans are less risky in some ways for borrowers, they are more risky for lenders. As a result, unsecured loans typically carry higher interest rates in comparison.

Even though these loans aren’t backed by an asset, missing payments can still have some pretty serious ramifications. First, as with secured loans, missed payments can negatively impact your credit score. A delinquent or default credit reporting can make it harder to secure additional loans, at least in the near future.

Not only that but if a borrower fails to pay off the unsecured debt, the lender may hire a collections agency to help them recover it. The collections agency may continually contact the borrower until arrangements to pay are made.

If that doesn’t work, the lender can take the borrower to court and ask to have wages garnished or, in some extreme cases, may even put a lien on an asset until the debt is paid off.

Managing Secured and Unsecured Debt

Knowing whether a loan is secured or unsecured is one tool to help you figure out how to prioritize paying off your debt. If you’ve got some extra cash and want to make additional payments, there are a number of strategies for paying down your debt.

You might consider prioritizing your unsecured debt. The relatively higher interest typically associated with these debts can make them harder to pay off and could end up costing you more money in the long run. In this case, you might consider a budgeting strategy like the avalanche method to tackle your debts, whereby you’d direct extra payments toward your highest-interest rate debt first. (Be sure you have enough money to make at least minimum payments on all your debts before you start making extra payments on any one debt, of course.)

You can also manage your high-interest debt by consolidating it under one personal loan. A personal loan can be used to pay off many other debts, leaving the borrower with only one loan — ideally at a lower interest rate. Shop around at different lenders for the best rate and terms you can find.

However, it can be smart to be cautious of personal loans that offer extended repayment terms. These loans lengthen the period of time over which you pay off your loan and may seem attractive through lower monthly payment options. However, choosing a longer term likely means you’ll end up paying more in interest over time.

Recommended: How to Apply for a Personal Loan

The Takeaway

Secured debt is backed up by collateral, such as a house. Unsecured debt doesn’t require collateral. The type of debt a borrower chooses may impact things like the cost of a loan and whether they can get credit. It can also help determine the order in which debt is repaid. Since unsecured loans could have higher interest rates or fees, you may decide to consider prioritizing paying down that debt first. Consolidating high-interest debt under one personal loan, ideally at a lower interest rate, is another strategy.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What is an example of an unsecured loan?

An example of an unsecured loan would be an unsecured personal loan. In this case, your financial credentials are evaluated when you apply, but you don’t have to put up an asset as collateral to obtain the loan.

Is it better to get an unsecured or secured loan?

This decision depends on your needs and your situation. A personal loan can be faster to obtain and typically doesn’t require collateral, but the interest rate may be higher than what you would be offered for a secured loan, in which you put up collateral and likely face a longer path to approval.

What’s the difference between a secured and unsecured loan?

With an unsecured loan, you don’t have to put up collateral. With a secured loan, you do, such as using your house as collateral for a home equity loan. Typically, secured loans are seen as lower risk to lenders and therefore have lower interest rates.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q225-098

When you’re buying a new or used vehicle, you might prefer to finance your purchase with an auto loan rather than pay cash up front. Auto loans may offer favorable interest rates for buyers with good credit history and stable income. Before signing off on any vehicle financing, however, it’s important to be sure you understand some basic auto loan terminology.

Here’s a brief glossary of basic car loan definitions that can help you select the right borrowing option.

Auto Loan

A vehicle loan is essentially a contract between the car buyer and the financing company or lender. This contract spells out the conditions for completing the purchase of the vehicle and lays out exactly how the loan will be repaid over time.

Banks, credit unions, online lenders, and financing companies are all places you can get an auto loan. Dealerships may also offer in-house financing, in which you repay an auto loan directly to the dealer.

Recommended: What Is a Buyer’s Order for a Car?

Annual Percentage Rate

Annual percentage rate (APR) is one of the most important car finance terms to know because it relates to how much you’ll pay for a vehicle loan. APR is a reflection of the annualized cost of borrowing money, based on the interest rate and fees charged by the lender.

In auto loan terminology, APR gives you a simple way to compare the cost of different vehicle loans. Say you have two lenders you’re considering for vehicle financing. One offers a loan with a 3.99% APR, while the other is advertising a 2.99% APR. Of the two, the second loan will cost you less money in interest over time.

When you’re comparing APRs for vehicle loans, pay attention to whether interest rates are fixed or variable. A fixed APR stays the same for the life of the loan, which means you can easily calculate the total amount of interest you’ll pay. Your monthly payments will also stay the same for the life of the loan. This tends to be the most common type of car loan.

With variable-rate auto loan financing, the APR is tied to a benchmark rate, such as the prime rate. If the benchmark rate increases or decreases, the loan’s APR can also change. This makes it more difficult to predict total interest costs, and monthly payments may not stay the same throughout the life of the loan.

Base Price

When you’re applying for auto loan financing, you may see the term “base price” mentioned. Base price reflects the purchase price of the vehicle as is, without add-ons. The actual purchase price may be higher if you add on optional equipment, upgrades (like that premium sound system you’ve had your eye on), or purchase extended warranties or maintenance contracts.

Cosigner

Lenders typically use credit scores to determine whether you’re eligible for an auto loan or an auto loan refinance and what interest rate they’ll charge you. (The higher your score, the more likely you are to get the best, or lowest, interest rates.) If you don’t meet a lender’s minimum credit score and income requirements, you may need a cosigner if you want to finalize the loan.

An auto loan cosigner is someone who agrees to assume equal responsibility with you for an auto loan. If you default on the loan and fail to pay it back, the cosigner is liable for repaying what’s owed. A cosigner is usually a relative or significant other with a solid credit history. Keep in mind, though, that only the person whose name is on the title has legal rights to the vehicle itself.

Deficiency Balance

If you fail to repay your loan and your vehicle gets repossessed and sold by your financing company to recoup its losses, and you owe more on the car than the company is able to sell it for, the financing company can still hold you responsible for paying the difference. That gap is called the deficiency balance. You may also be responsible for paying any repossession fees.

Down Payment

A down payment is a payment you make upfront against the purchase price of a vehicle you’re buying. This is similar to a down payment you might make on a home — the goal in both cases is to reduce the amount you need to finance.

Depending on your credit and where you’re buying your vehicle, you may be able to get auto loan financing with no money down. But there are some advantages to making a larger down payment. For one thing, you’ll have a smaller loan, which means less money you’ll pay in interest over the life of the loan. A smaller loan can also lower your monthly payments, which can make financing a vehicle more affordable for your budget.

Recommended: Does Financing a Car Build Credit?

Extended Warranty

If you’re buying a new or used vehicle from a dealer, you might be asked if you want to purchase extended warranty coverage. Extended warranties may cover basic maintenance or repairs to the vehicle for some time beyond the original manufacturer’s warranty.

Whether it makes sense to pay extra for an extended warranty can depend on the age of the vehicle, how long you plan to own it, and how much cash you have in reserves to cover repairs and maintenance. The cost of an extended warranty can be added to your auto loan’s terms, meaning it would affect your monthly payment.

Interest Rate

The interest rate on a vehicle loan is simply the rate that’s charged annually, without factoring in any fees. Interest rate was already mentioned as a part of your APR, but it’s helpful to know what it means by itself, too.

A lower interest rate can translate to a lower APR, but when you’re comparing car finance terms, you mustn’t get the two of them confused. If you have two loans you’re considering, you may want to look at each of their interest rates side by side as well as their APRs to get a sense of the costs. That way, you’re comparing apples to apples vs. apples to oranges, as the saying goes.

Recommended: 144 Month Auto Loans

Loan Term

A car loan term simply means how long you’ll make payments on the loan. Auto finance terms may largely depend on how much you’re borrowing. A larger loan amount might require a longer loan term so that your monthly payments are affordable for your budget. A smaller loan may require less time to pay off.

Usually, car loans range from two years to eight years, though you may find exceptions. A loan term of five or six years is common.

Monthly cost is important to consider when choosing a car loan term, but also think about what the timeframe means in terms of how much interest you’ll pay. Generally, the longer the loan term, the more the interest charges will add up over time. Paying off a shorter loan term could make the payments higher, but it can reduce the amount of interest you’ll pay altogether.

Loan to Value Ratio

Loan to value ratio (LTV) represents the total dollar value of your vehicle loan divided by the car’s actual cash value. Actual cash value is what the car is worth according to independent valuation providers, such as Kelley Blue Book. Making a larger down payment can reduce your LTV ratio.

Recommended: How to Sell a Car You Still Have a Loan On

Principal

When it comes to car loan definitions, it’s important to understand that auto loan principal is terminology for the amount you owe minus any interest, fees, or finance charges. When you make payments on a vehicle loan, part of what you pay is applied to the fees and interest, while the rest is applied to the loan’s principal.

Your lender or financing company should provide you with an amortization schedule that breaks down how your payments are applied. Typically, a higher percentage of your payments will go toward interest and fees during the early part of your loan term. Once most of the interest is repaid, more of your payments will go toward the principal.

Total Cost

Total cost is a simple car loan term that means the total amount you’ll pay for financing. This amount includes the principal, interest, fees, and any money you apply toward a down payment.

Recommended: Smarter Ways to Get a Car Loan

The Takeaway

Auto loans can vary, so it’s important to understand the terminology and to do your research before selecting one. When you’re comparing vehicle financing options, it’s a good idea to consider what different lenders offer in terms of interest rates, fees, repayment terms, and loan amounts.

If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.

FAQ

What is the typical term for a car loan?

Car loan terms usually range from two to eight years, with five or six years being typical.

Are most car loans fixed-rate or variable?

Most car loans are fixed-rate, but variable-rate loans may also be available. While a fixed-rate loan could end up being more expensive if rates drop, it can be helpful to have a consistent monthly payment when budgeting.

What is a car loan’s APR?

A car loan’s APR is the annual percentage rate. This figure reflects the interest rate plus any other fees and loan costs. It more accurately reflects the cost of the loan than simply the interest rate.

Photo credit: iStock/takasuu

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOALR-Q225-033

Convertible bonds are a type of corporate debt security that provide fixed-income payments like a bond, but can be converted to common shares of stock. As such, they’re often referred to as “hybrid securities.”

Most convertible bonds give investors a choice. They can hold the bond until maturity, or convert it to stock at certain times during the life of the bond. This structure protects investors if the price of the stock falls below the level when the convertible bond was issued, because the investor can choose to simply hold onto the bond and collect the interest.

How Do Convertible Bonds Work?

Companies will often choose to issue convertible bonds to raise capital in order to not alienate their existing shareholders. That’s because shareholders may be uneasy when a company issues new shares, as it can drive down the price of existing shares, often through a process called stock dilution.

Convertible bonds are also attractive to issue for companies because the coupon — or interest payment — tends to be lower than for regular bonds. This can be helpful for companies who are looking to borrow money more cheaply.

What Are the Conversion Ratio and Price?

Every convertible bond has its own conversion ratio. For instance, a bond with a conversion ratio of 3:1 ratio would allow the holder of one bond to convert that security into three shares of the company’s common stock.

Every convertible bond also comes with its own conversion share price, which is set when the conversion ratio is decided. That information can be found in the bond indenture of convertible bonds.

Convertible bonds can come with a wide range of terms. For instance, with mandatory convertible bonds, investors must convert these bonds at a pre-set price conversion ratio.

There are also reverse convertible bonds, which give the company — not the investor or bondholder — the choice of when to convert the bond to equity shares, or to keep the bond in place until maturity.

But it also allows the investor to convert the bond to stock in the case where they’d make money by converting the bond to shares of stock when the share price is higher than the value of the bond, plus the remaining interest payments.

In general, these options are not available when investing online.

How Big Is the Convertible Bond Market?

As of 2024, the size of the U.S. convertible bond market was estimated to be about $270 to $280 billion. Securities have been issued by hundreds of companies. But note that these numbers are miniscule compared to the U.S. equity market, which has trillions in value and thousands of stocks.

The total size of the convertible bond market does expand and contract, though, often with the cycling of the economy. In 2024, the total convertible bond issuance reached nearly $88 billion, versus $55 billion in 2023, and $29 billion in 2022. This may reflect the higher interest-rate environment, and companies’ desire to minimize debt payments.

Recommended: How Does the Bond Market Work?

Reasons to Invest in Convertible Bonds

Why have investors turned to convertible bonds? One reason is that convertible bonds can offer a degree of downside protection from the bond component during stock volatility. The companies behind convertibles are obligated to pay back the principal and interest.

Meanwhile, these securities can also offer attractive upside, since if the stock market looks like it’ll be rising, investors have the option to convert their bonds into shares. Traditionally, when stocks win big, convertibles can deliver solid returns and outpace the yields offered by the broader bond market.

For example, in 2024, the U.S. convertibles market returned 11.4%, outpacing the performance of all major fixed-income indices. And over the 10-year period ending December 31, 2024, convertible bonds have delivered a higher yield than equities, according to data by Bloomberg.

Recommended: Stock Market Basics

Downsides of Convertible Bonds

One of the biggest disadvantages of convertible bonds is that they usually come with a lower interest payment than what the company would offer on an ordinary bond. As noted, the chance to save on debt service is a big reason that companies issue convertibles. So, for investors who are primarily interested in income, convertibles may not be the best fit.

There are also risks. Different companies issue convertible debt for different reasons, and they’re not always optimal for investors. Under certain conditions, convertible financing can lead to “death spiral financing.”

What Is Death Spiral Debt?

The death spiral is when convertible bonds drive the creation of an increasing number of shares of stock, which drives down the price of all the shares on the market. The death spiral tends to occur when a convertible bond allows investors to convert to a specific value paid in shares, rather than a fixed number of shares.

This can happen when a bond’s face value is lower than the convertible value in shares. That can lead to a mass conversion to stock, followed by quick sales, which drives the price down further.

Those sales, along with the dilution of the share price can, in turn, cause more bondholders to convert, given that the lower share price will grant them yet more shares at conversion.

How to Invest in Convertible Bonds

Most convertibles are sold through private placements to institutional investors, so retail or individual investors may find it difficult to buy them.

But individual investors who want to jump into the convertibles market can turn to a host of mutual funds and exchange-traded funds (ETFs) to choose from. But because convertibles, as hybrid securities, are each so individual when it comes to their pricing, yields, structure and terms, each manager approaches them differently. And it can pay to research the fund closely before investing.

For investors, one major advantage of professionally managed convertible bonds funds is that the managers of those funds know how to optimize features like embedded options, which many investors could overlook. Managers of larger funds can also trade in the convertible markets at lower costs and influence the structure and price of new deals to their advantage.

The Takeaway

Convertible bonds are debt securities that can be converted to common stock shares. These hybrid securities offer interest payments, along with the chance to convert bonds into shares of common stock.

While convertible bonds are complex instruments that may not be suitable for all investors, they can offer diversification, particularly during volatile periods in the equity market. Investors can gain exposure to convertible bonds by putting money into mutual funds or ETFs that specialize in them.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQ

Why would an investor choose convertible bonds?

Convertible bonds offer downside protection for an investor’s principal, and also offer the potential to see equity gains as well.

What is the difference between a corporate bond and a convertible bond?

The main difference is that a corporate bond pays a fixed rate of interest that’s typically higher than a convertible bond coupon. But a regular corporate bond doesn’t offer access to an equity upside the way a convertible bond can.

Can a convertible bond be converted into cash?

Yes. First, in some cases a convertible bond may offer the option to convert to cash value rather than a pre-set number of company shares. Then, there is always the option to redeem the bond at maturity for its cash value.

SoFi Invest®