What is Unsecured Debt?
When you are taking on debt, you are better off understanding the fundamentals of how credit works so that you can responsibly manage it as part of a good money management plan. Similarly, if you are in debt and trying to pay it down, understanding the different kinds of debt can help you prioritize and make your efforts more effective.
You should be financially literate to achieve all your financial goals. The more you know about various credit products, the better you will be at choosing products and/or strategies that can assist you in achieving those goals. On the flipside, if you commit to credit without understanding how it works, or how it works into your budget, you may find yourself in over your head before too long,” says Jeff Schwartz, Executive Director, Consolidated Credit Counseling Services of Canada.
Want to learn more about the different kinds of debt and what your best strategy is to pay it down? Call us at 1-844-402-3073 or get started with our online debt analysis.
Understanding different types of debt can help you with debt repayment solutions, save money on interest and build up your wealth. Let’s start with looking at what is unsecured debt and what the differences between unsecured debt and secured debt are.
What is Unsecured Debt?
Generally speaking, unsecured debt refers to any kind of debt that is not linked to an asset. For the most part, this includes your credit cards, lines of credit, medical bills, payday loans, consolidation loans or other installment loans that aren’t backed by assets.
Unlike with secured debt (which we will look at next), if you default on your payments with your unsecured debt, the lender doesn’t call back the items that you used your unsecured credit to buy for payment.
From a creditor’s standpoint, unsecured debt is riskier, because there is no asset that they can hold against the debt in the event that you don’t make their payments. When it is a bigger risk for the lender, they charge higher interest rates to compensate, which is passed on to you, the debtor.
Although unsecured debt isn’t tied to an asset, it doesn’t mean that your assets aren’t involved if you should default on your payments. If you have outstanding debt and own a home or other assets, technically the lender is allowed to register a lien against your home or assets to try to force you to repay the debt. Typically, once the debt is repaid, the lien is lifted. Theoretically, if you didn’t repay your debt, the creditor could force the sale of your home or other assets to collect their money. This is a worst-case scenario, but the possibility exists.
Everything you need to know about secured debt
Secured debt is debt that is tied directly to an asset. For instance, a mortgage is a secured debt because it is tied to the asset of a house. A car loan is a secured debt because it is tied to the value of a car. Homeowners often have a Home Equity Line of Credit (HELOC), which is revolving credit (i.e. you can reuse it up to the maximum limit when you pay the balance down). As a HELOC is secured against equity built up in a home, interest rates tend to be lower. This is a popular choice for things like home renovations because you have more flexibility in taking out the money that you need for a project, as you need it.
You can even have secured debt on a credit card if you pledge cash or a similar asset to against the credit limit.
“One of the criteria for acquiring credit is a good credit history, which can be a problem if you don’t have credit to begin with. Getting a secured small balance credit card and repaying it on time every month is a good way to establish your credit history. Lenders are amenable to this because their risk is greatly diminished if there is an asset held against the credit card,” says Schwartz.
What this does is give your lender recourse if you are unable to pay back your debt; the agreement is that they can take over your asset, or force you to sell the asset and pay the debt.
It is important to note that secured debt and the asset held against it are linked. Basically, you aren’t able to keep the asset if you don’t repay the debt.
How to plan and prioritize debt repayment
If you are deep in debt and cash flow is a problem, you may have to prioritize your debt payments. Usually, it is advisable to repay your secured debts first so that you are able to keep assets as you work on paying your debts down.
If you are really struggling with debt, you may even consider selling assets and using the proceeds to pay down the secured debt, and possibly unsecured debt too. For instance, if you own a home, you might consider selling your home, taking out the equity that you’ve built up and paying down the debt. You can downsize and get a debt-free start to get back on track financially.
If you are mostly dealing with unsecured debt and don’t really have any assets to rely on, your best bet is usually debt consolidation to build up your cash flow and stop the debt cycle from churning. Depending on your financial situation, a DIY debt consolidation may be the best option. If that isn’t possible, you can look at dealing with your unsecured debt through a Debt Management Program (DMP).
If you are able to make your payments but are motivated to pay down your debt on your own, pick the highest interest rate debt first. That debt is the most expensive, so getting rid of it first is an effective approach.
What should I do next?
If you are seeking debt relief, it is important to get in touch with a trained credit counsellor. He or she will analyze your unique situation and help you understand the difference between secured and unsecured debt. Remember, not all debts are able to be included uniformly in various debt relief options.
Ready to get debt-free? Get in touch with us today. Call our trained credit counsellors for more information at 844-402-3073 or check out our online debt analysis.