Debts fall into two broad categories: secured debt and unsecured debt. Stop paying one and in addition to credit issues and loan collectors, you could also lose a major asset, like your house or car.
Stop paying the other and you could ruin your credit and debt collectors could come a-knocking. It’s crucial to know the difference between the two—and what’s at stake—before taking on either kind of 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 offer some easier qualifying criteria. For example, secured loans may have less stringent requirements for credit score vs 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. Consider that 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 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.
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 hound 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.
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, but choosing a longer term likely means you’ll end up paying more in interest over time.
What’s Right for You?
Everyone’s financial situation is different, so what works for one person may not work for another. If you’re interested in an unsecured personal loan, consider SoFi.
With competitive interest rates and flexible options for a fixed monthly payment, you can explore options to consolidate credit cards and/or other high-interest debt or make a major purchase. It only takes minutes to check your rates.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
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