In the world of finance, there are so many different types of debt that it can be really tough to wrap your head around those differences. Furthermore, when you find yourself struggling to make the minimum payments or trying diligently to get out of debt those subtle differences can be easy to ignore. In an effort to help you make some sense of those differences, we thought we’d take the time to explain two of the most common types, secured and unsecured debt, and what those differences mean to you.
Secured Debt: When a debt is secured, this means that an asset has been used as collateral when borrowing the money. This gives the lender more security and reduces his/her risk against default.
When you take out a secured debt, but fail to make payments on it, the lender then has a recourse to secure the money owed (usually that means selling that asset to recover the losses).
For most people, the largest secured loan is a mortgage. When you take out a mortgage, this loan is secured by the house itself. However, there are several other types of common secured debts, including car loans or loans secured by investments (i.e. property).
In bankruptcy, most secured loans are not released, meaning they are not covered by the bankruptcy contract, and thus if you claim bankruptcy these are not included in the term or payments.
Unsecured Debt: When a debt is unsecured, this typically means that there is no security behind a loan, and thus the lender runs a higher risk of not recovering their money if you default on a loan. Since there is more risk, this usually means that the interest rate on unsecured debt is significantly higher than secured debt.
There are several types of unsecured debt, but the most common is credit card debt. Other types include student loans, payday loans, or other bills (i.e. utilities).
Unlike a secured debt where your creditor can just use the collateral to recoup their losses, with unsecured debt this is not an option. However, they may use other avenues, such as a collection agency, garnishing your wages, or placing a lien on your assets until you have paid off the debt.
In bankruptcy, these are the types of debts that are included, and thus wiped out in exchange for a
monthly payment in bankruptcy.
When you are in debt, it usually makes sense to pay off more of those secured debts first because there is often more to lose if you default on these. However, when looking to make larger than minimum payments, start with the unsecured debts because they often carry much higher interest rates.
For more about secured vs. unsecured debt, and how to prioritize when trying to get out of debt, please contact DebtCare Canada today by calling 1-888-890-0888.