Understanding Secured Debt versus Unsecured Debt

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Understanding Secured Debt versus Unsecured Debt

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Understanding the difference between secured debt and unsecured debt can be difficult.

It is important to understand the difference as there are different legal implications when you are paying off your debt and different priorities to considerfor secured versus unsecured 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.

Let's take a look at the difference.

Secured Debt

  • Secured debt is backed or secured by collateral such as a car, house, or similar asset that the lender uses as security in the event the borrower cannot meet the repayment terms.
  • With secured debts, if you fall behind on payments, the lender has specific legal rights to take ownership of the asset used to back the loan or was used as collateral for the debt and sell it in order to place those funds towards the loan balance.
  • It is also important to note that you may remain liable for the rest of the balance owed on the debt after the asset has been repossessed and sold.
  • Secured loans usually offer more attractive interest rates because, even if the borrower defaults on the loan, the lender is still able recover all, or most of the loan, through repossession or foreclosure.
  • More and more we are seeing that mortgage lenders want to work with consumers to resolve payment problems and avoid foreclosure. Lenders are familiar with people in default on their home loans and often have established programs and policies to deal with such situations. A rewrite can help you find the right payment solution. For more information visit MakingHomeAffordable.gov.  

Unsecured Debt

  • Unsecured debt is debt in which you borrow from a creditor to obtain goods or services on credit in exchange for your promise to repay the debt.
  • Unsecured debt is not collateralized by personal property as with secured debt.Some examples of unsecured debts include credit cards, some types of personal loans, and medical bills.
  • Unsecured loans often have higher interest rates because the lender does not have collateral to recoup their losses, in the event the borrower defaults on the loan.
  • If you fall behind on an unsecured debt, lenders can pursue collection activity and take legal action against you. However, many times the lender may try to work out reasonable payment arrangements. Many times 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. 

When entering any agreement whether secured or unsecured it is important to review the terms and conditions of repayment and consequences for falling behind before signing. While most have good intentions and don't think they will default on a loan when they are entering into an agreement, life circumstances can sometimes put you in an unpredictable situation; therefore it is best to make sure you understand all of the repayment terms in any agreement.

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  • This is great, but what about those companies who give you a "secured" debt based on a faux collateral (mine's an old TV - they never saw it) and charge you outrageous interest?

    Citifinancial has done this to me. I cannot get them to lower their 29% interest, although because of CareOne, they have lowered my monthly payment. (which helps my monthly bills, but keeps me still horribly in debt). Each month, I am paying  130 dollars interest and 25 dollars to the actual debt. At this rate, it will be eons before I will have it paid off.

    Why doesn't Citifinancial have to go by the same rules as everyone else?

    Thanks,

    Kris

  • Hi Kris,

    Thanks so much for your question! Unfortunately, these types of accounts are in place for individuals who have had previous credit challenges. The creditors typically know they will never see the “secured item” and as a result charge higher interest rates. The creditor is not doing anything illegal as participation in the plan and any benefits offered are totally voluntary for the creditor.

    I would suggest making extra payments to this creditor when you can afford to do so as this will help reduce the amount of interest paid overall.

    Thanks again,

    Coach Tammy

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