There are two major types of debt: secured and unsecured. One is effectively anchored by your property: A creditor can seize it then sell it if you default and stop paying on the loan. An unsecured creditor has less of a safety net.
Knowing the difference is important when you're borrowing money and prioritizing debt repayment.
What's the Difference Between Secured and Unsecured Debts?
|Secured Debts||Unsecured Debts|
|The lender holds a lien against your property so it can foreclose or repossess to satisfy the debt if you don't pay.||The lender is limited to suing you in court or turning the debt over to a collection agency if you don't pay.|
|You could lose the property that acts as collateral.||You'll probably pay a higher interest rate because the debt isn't secured.|
Secured debts are legally attached to and literally secured by an asset. Lenders place a lien on the asset, giving them the right to seize it through repossession or foreclosure if you stop paying on the loan and fall delinquent. The asset serves as collateral for the debt, so it will be sold, often at an auction, after the lender takes possession of it.
The lender can pursue you for the difference, referred to as a deficiency balance, if the sales price of the asset doesn't cover your entire debt. Their ability to do so depends on the terms of your contract and sometimes on state law.
You don't fully and legally own the asset tied to the secured debt until the loan is paid off. The lender should remove the lien and release the asset at this point, and the title should be transferred to you free of any liens.
Lenders of unsecured debts do not have rights to any collateral. They generally cannot claim your assets for repayment of the debt if you fall behind on your payments unless they sue you and get a judgment against you in court. The judgment acts as a sort of lien in this case.
An unsecured lender isn't without recourse, however. It can take other actions to get you to pay what you owe if you default. It might hire a debt collector to pursue you and try to get you to pay the debt. A successful lawsuit can be used to garnish your wages, take an asset that wasn't tagged as collateral, or put a lien on your assets until you've paid off your debt. This guarantees that the lender will be paid when you sell them.
Lenders of secured debts take collection actions, too, typically before they repossess or foreclose on the collateral for your loan.
Examples of Secured Debts
Mortgages and auto loans are both examples of secured debts. Your mortgage loan is secured by your home. Similarly, your auto loan is secured by your vehicle. The lender can foreclose or repossess the property if you become delinquent on these loan payments.
A title loan is also a type of secured debt because the debt is secured by the title to a vehicle or other asset.
Examples of Unsecured Debts
The Bottom Line
It's important to keep up the minimum and installment payments on all your accounts, but times might come when you have less money available to do that.
Secured debts are typically the best choice to pay first if you're strapped for cash and you're faced with the difficult decision of paying only some of your bills. These payments are often harder to catch up with, and you stand to lose essential assets if you fall behind on the payments.
You might give more priority to unsecured debts if you're making extra payments to pay off some debt. Unsecured debts often have higher interest rates, so they can take longer to pay off. This can result in higher amounts paid overall because interest continues to accrue monthly.