Many of us think that debt is debt. However, there are two main categories of debt—secured and unsecured. If you find yourself in a tough spot financially, knowing which of your debts fit into these two categories can help you make a more financially sound game plan in the event that you are unable to pay all of your bills. Here are the main differences between secured and unsecured debt.
The key feature of a secured debt is that it is attached to an asset. The two most common types of secured debts include mortgages and auto loans. In the case of a mortgage, the money that is borrowed is tied to the house, which the lender treats as collateral according to “Why You Need to Know the Difference Between Secured and Unsecured Debt.” If for whatever reason you are unable to continue making payments, the lender can start the foreclosure process and seize your home.
Just like a mortgage, auto loans are attached to the vehicle. If you stop making payments, they can take procession of your car. In both instances, this protects the lender. By taking control of the asset, this allows them to recoup their losses.
According to Investopedia, the risk of default on a secured debt tends to be lower because the borrower has more to lose, such as their home or car. It is for this reason that it is usually easier for an individual to acquire. Moreover, since the risk is lower for the lender, the interest rate tends to be lower.
Inversely, unsecured debt is when there isn’t a tied asset. The most common type of unsecured debt that many people have is credit cards. Other examples of unsecured debt include medical bills, student loan debt, and court-ordered child support. So, if you fail to make payments, there is no asset for the lender to take.
However, that doesn’t mean there aren’t any steps that they can take to come after you for this debt. The lender may hire a debt collector to try to get the owed money from you according to the article “The Difference Between Secured and Unsecured Debt.” If this fails, then they may attempt to sue you in an attempt to garnish your wages. They can also ask the court to seize one of your assets or place a lien on one of them. Moreover, if you are more than 30 days past due on your payment, it will be considered officially late, and your credit score can fall by one hundred points or more.
Which One Should I Pay First?
If you need to make a payment strategy to handle your debt due to a difficult financial situation, then you should at least handle your secured debts. The last thing you want to happen is to lose an asset like your home or vehicle. To avoid being late on a credit card payment or other unsecured debts, try to make the minimum payments that way you won’t end up being late. Once you get to a better place financially, then you can start making larger payments on your unsecured debts.