Jimmy asked:


Secured vs unsecured debt

Many people find themselves mired in debt without understanding what exactly they have. They understand that they owe money to various lenders, and they know how much, but they don’t know why these debts have varying payment requirements and interest rates. Why do some debts require collateral, while others do not? Why do credit cards charge so much interest? What sort of debts should be paid off aggressively, and which can be permitted to sit? In order to answer all these questions, it’s necessary to understand the difference between secured and unsecured debt.

Secured debt is debt which has collateral involved. Collateral is any piece of property which is offered up as an assurance that the loan will be paid by the debtor. In the event that the loan is not paid, the lender will be given ownership of the property. Secured debt is thus most commonly used when a borrower wishes to purchase a large, expensive piece of property, since this means the purchase will require a large amount of money and also that in the event of default, the lender will be in possession of something valuable. This is why auto loans and mortgages are secured debts, in the event that the borrower is unable to pay the interest payments, the lender will gain ownership of a car or house, which they can sell to make up for the money they will not be able to collect from the borrower. Secured debt gives the lender security in the knowledge that they will end up making money either way, and so secured debt tends to require smaller payments over longer periods of time, and with less interest, than unsecured debt.

Unsecured debt is money which is leant out purely on the faith that the borrower will pay. While this may sound risky, the vast majority of borrowers are honest and responsible people who pay back money quickly. Indeed, in the modern economic world, essentially everyone has been given at least some unsecured debt. This is most commonly done using a credit card, although there are many other forms of unsecured debt. Unsecured debt is often easier to get than secured debt, since no collateral is required. Unfortunately, because there is less assurance that the lender will still make money, unsecured debt tends to have higher rates of interest. Anyone familiar with how quickly credit card bills accumulate when compared to, say, car loan payments, will be familiar with how high unsecured debt interest rates tend to be. Unsecured debt also tends to be dependent on a person’s reputation and ability to pay back loans, and so those with bad credit or no credit may find it difficult or expensive to get. It is also easy to get trapped in large amounts of unsecured debt since it is often given out carelessly and with no consideration as to the borrower’s ability to repay it, since the high rates of interest usually mean that the lender makes a profit even in the event of a default.

Because of the hazardous nature of unsecured debt as compared to secured debt, it is important to avoid unsecured debt and make efforts to pay it down quickly. While the fear of losing a house or a car may drive someone in high levels of debt to pay down their mortgage or car loan first, this will cost them money in the long run as their credit card bills begin to balloon. Persons with large amounts of unsecured debt should look into consolidating their debt by taking out a single secured debt and using it to pay off all their unsecured debts. This form of debt consolidation is offered by many banks and get-out-of-debt services and charities. Of course, one mustn’t neglect secured debt, since any form of debt is dangerous when allowed to accumulate, but the lower rates of interest due to the presence of collateral tend to make secured debt much easier to pay off.

n become hazardous when it is excessive, but small quantities of debt are useful in increasing quality of life and spending power. Persons who are in a large amount of debt should not be afraid to take on additional debt for essential purchases so long as that debt is manageable. Those who are worried that their unsecured debt is ballooning should seek counseling, and those who are having trouble paying off secured debt should negotiate with their lender. Many persons who have the collateral and income necessary for secured debt are considered good risks by banks and may be able to negotiate lower rates of interest or payments. Barring that, persons who must default on any loan should seek help in softening the blow. Losing a house and access to credit may be jarring, but it is not the end of the world.