Secured vs Unsecured Debt
Do you know what type of debt you have? Debts can be secured or unsecured.
It is important to know the difference, because only unsecured debts are eligible for debt consolidation.
A secured debt is a loan that is legally tied to an asset (e.g. a home, a car, or some other type of valuable property) that you own (called the "collateral"). If you default on the loan (fail to make the payments), the creditor has the right ("lien") to take possession of your property, sell it, and satisfy the debt out of the proceeds. If the selling price doesn't completely cover the debt, the creditor may obtain a deficiency judgment and pursue you for the remaining amount.
A car loan and a mortgage loan are both typical examples of secured debt. Your auto loan is secured by your vehicle (the lender has a lien on your car). Your mortgage loan is secured by your home (the lender has a lien on your home). A foreclosure is when mortgaged property is sold to pay the debt of the defaulting borrower.
Examples of secured debts (can't be consolidated):
- Home Loans
- Auto Loans
- Government Loans
- IRS Debt and Back Taxes
Special type of secured debt (can be consolidated)
- Federal Student Loans: can be consolidated into a Federal Direct Consolidation Loan
Pros of secured debt
- A secured loan will generally offer a lower interest rate compared to an unsecured loan due to the added security for the lender.
- Additionally, you can normally borrow the money over a longer repayment period, which will further reduce your monthly payments.
- Because they are guaranteed by your property, secured loans allow you to borrow large amounts of money.
Cons of secured debt
- Secured debt gives the lender a claim on your property, so if you don't keep up with your payments you can lose your property.
- The extended repayment period typical of a secured loan means you'll pay more interest in the long term.
- Secured debt can't be consolidated.
An unsecured debt is based solely on your promise to pay. You have not pledged any property to secure that debt.
Credit card debt and medical bills are an example of unsecured debt.
Creditors do not have liens (a right to take possession) on any of your assets.
If you don’t pay, the creditor will first try to convince you to pay (directly or through a credit collection agency) and then, if you still haven't paid, he can go into court and sue you. Once the creditor obtains a judgment, he can seize your property, put a lien on an asset (so you can't borrow against it or sell it without paying off the debt), garnish your wages (take a portion of them each pay period, assuming wage garnishment is legal in your state), or agree to a voluntary wage assignment.
A special case of debt are federally-insured student loans: the Department of Education can garnish up to 15% of your disposable income without a court judgment.
Pros of unsecured debt
- When the loan is unsecured, if you fail to repay the loan, the lender cannot take possession of your property.
- Unsecured debt can be consolidated.
Cons of unsecured debt
- The interest rate is usually higher compared to a secured loan, because the loan is not secured.
- The interest rates which are advertised are usually restricted to customers with an excellent credit score.
Examples of unsecured debts (can be consolidated):
- Credit Cards
- Personal Loans and Lines of Credit
- Medical Bills
- Student Loans
- Business Debts