The Difference Between Secured and Unsecured Debts
Which Type of Debt is More Important?
When it comes to debt, there are two major types: secured debt and unsecured debt. Knowing the difference is important for borrowing money, for prioritizing your debts during payoff, and for making sure you don't lose any assets that may be tied to your debts.
Secured debts are tied to an asset, like a house or car. The asset is typically considered collateral for the debt, hence why it's called a "secured" debt. Lenders place a lien on the asset, giving them the right to take back, e.g. repossess or foreclose, the asset if you fall behind on your payments. If the lender has to take your asset because you've become delinquent on your payments, the asset will be sold often in an auction to the highest biller. And, if the selling price for the asset doesn't completely cover the debt, the lender may pursue you for the difference between the selling price and your outstanding balance on the secured debt.
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 you've tied your vehicle to the debt.
You never fully own the asset tied to secured debt until the loan has been 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 don't have rights to any collateral for the debt. If you fall behind on your payments, they generally cannot take any of your assets for the debt.
While they can't take back 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 another your assets until you've paid your debt. They'll also report the delinquent payment status to the credit bureaus so it can be reflected on your credit report. Lenders of secured debts take these actions, too.
Prioritizing Secured and Unsecured Debts
If you're strapped for cash and 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 - like 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 that makes it expensive to spend a long time paying these off. Even when you're in debt repayment mode, it's important to keep up the minimum and installment payments on all your accounts.