The Difference Between Secured and Unsecured Debts
Which Type of Debt is More Important?
There are two major types of debt: secured and unsecured. Knowing the difference is important when borrowing money and prioritizing debt repayment.
Secured debts are secured by an asset, such as a house or car. The asset serves as collateral for the debt (hence why it's called a "secured" debt). Lenders place a lien on the asset, giving them the right to seize (e.g., repossess or foreclose) it if you become delinquent. If the lender takes the asset, it will be sold (often at an auction). If the selling price for the asset does not cover the entire debt, the lender may pursue you for the difference: the deficiency balance.
A mortgage and auto loan are both examples of secured debt. Your mortgage loan is secured by your home. Similarly, your auto loan is secured by your vehicle. If you become delinquent on these loan payments, the lender can foreclose or repossess the property. A title loan is also a type of secured debt because the debt is secured with title to a vehicle or other asset.
You never fully own the asset tied to secured debt until the loan is paid off. At that point, you can ask the lender to release the asset and give you a title that's free of any liens.
With unsecured debts, lenders do not have the rights to any collateral for the debt. If you fall behind on your payments, they generally cannot claim your assets for the debt.
While they can't claim your assets as repayment for your debt, the lender may take other actions to get you to pay what you owe. For example, they will hire a debt collector to coax you to pay the debt. If that doesn't work, the lender may sue you and ask the court to garnish your wages, take an asset, or put a lien on your assets until you've paid your debt. They'll also report the delinquent payment status to the credit bureaus to be reflected on your credit report. Consequently, lenders of secured debts take these actions, too.
Prioritizing Secured and Unsecured Debts
If you're strapped for cash and are faced with the difficult decision of paying only some bills, the secured debts are typically the best choice. These payments are often harder to catch up with and you stand to lose essential assets (e.g., shelter) if you fall behind on payments.
You might give more priority to unsecured debts if you're making extra payments to pay off some debt. Unsecured debts sometimes have higher interest rates, which can take longer to pay off and results in higher amounts paid. Even when you're in debt repayment mode, it's important to keep up the minimum and installment payments on all your accounts.