Secured vs. Unsecured Debt...Know the Difference

 Most people have a combination of secured and unsecured debt; when faced with financial hardship understanding the difference is important.

• Secured debt.  Secured debt is typically tied to assets such as your home and mortgage, and your car and car loan. In the event you stop making payments, lenders can foreclose on your house or repossess your car.
   
• Unsecured debt.  Unsecured debt is not tied to assets and can include credit cards, medical bills and collection accounts.

Good vs. Bad Debt

Your long term financial profile relies on a mix of both secured and unsecured debt used wisely, so it is in your best interest to have a mix of both.

• Good debt.  The purchase of your home through a mortgage is an example of good debt. In theory (not necessarily the case in today’s real estate market), your home is considered an investment, the opportunity to build wealth, as historically homes increase in value.  Therefore, your home would be considered “good” debt.
   
• Bad debt.  Bad debts are those that come from items that depreciate in value after you buy them. These debts are often created through the misuse of credit cards.  High interest rates, late and over-the-limit fees make many credit card purchases cost 10, 20 or even 30 times more than their original value.

Dealing with Debt

If you find yourself behind on payments, it’s important to understand the difference between secured and unsecured debt, as well as the different legal implications and priorities to consider for paying off your debt.

With secured debts, if you fall behind on payments, the lender has specific legal rights to take ownership of the asset that was used to back the loan or that was used as collateral for the debt. They can then sell it in order to place those funds toward the loan balance. If you default on a loan, the lender is still able to recover all, or most of the loan, through repossession or foreclosure.  Additionally, you may be liable for the remaining balance owed on the debt after the asset has been repossessed and sold.

If you fall behind on an unsecured debt, lenders can pursue collection activity and may even take legal action against you. Your account will also be charged with penalties, late fees, and possibly even legal fees for collection activities, which increase the total amount owed to the lender.  In the event you default on the loan, the lender does not have collateral to recoup their losses. Many times, however, the lender will try to work out reasonable payment arrangements.

Understanding the difference between secured and unsecured debt can help you prioritize your debt and determine your attack plan for getting out of debt. When agreeing to repayment terms for any type of debt, be sure to understand what you are getting into.

Read more about the effects of debt on your life in the CareOne blog A Straight Talk on Debt.

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