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Secured vs. Unsecured Debt: What Is the Difference?
By Nicole Symon MONEY RESEARCH COLLECTIVE
Debt can either be secured or unsecured. The critical difference between the two is that secured loans require you to put up an asset you own as collateral, while unsecured loans do not. This guide will offer an in-depth breakdown of both secured and unsecured debt, including the advantages and disadvantages of both.
What is secured debt?
Secured debt is financing that uses collateral to back up the loan. Collateral is an asset you own, like a car or house. Even cash deposits can function as collateral in some cases.
If you default on a secured debt, your creditor has the right to take the collateral as payment. Before you take on a secured debt, carefully weigh the possibility of losing your asset if you can’t repay your loan.
- Has higher borrowing limits
- Generally has lower interest rates
- Typically has more lenient credit eligibility requirements
- Includes the potential to lose your collateral if you default
- Could have fees to assess the value of your collateral
- May have limitations in how you can use the loan
Examples of secured debt
Some examples of secured debt include:
- Mortgages: Your home acts as the collateral for a mortgage. If you miss mortgage payments — typically once you’re 120 days past due — your lender may begin foreclosing on your house.
- Home equity loans: Like mortgages, home equity loans are guaranteed by your house.
- Auto loans: An auto loan is a secured debt that uses the car as collateral. If you stop making payments and default on your auto loan, your lender can repossess your vehicle.
- Secured credit cards: A secured credit card requires you to make a cash deposit — generally between $200 and $500 — as collateral. If you don’t make your payments, your credit card company will keep your deposit.
What is unsecured debt?
Unsecured debt is a loan with no collateral attached to it. Common types include traditional credit cards, student loan debt and most personal loans. Unsecured debt is riskier to lenders. Since the loan doesn’t require collateral, your lender cannot repossess your assets if you default. Instead, the lender must sue you or send your debt to collections.
- Doesn't require collateral
- Allows you to use the loan to finance almost anything
- Doesn't have collateral assessment fees
- Often has higher interest rates
- May be more difficult to qualify
- Has lower borrowing limits
Examples of unsecured debt
Some examples of unsecured debt include:
- Traditional credit cards: When you apply for a traditional credit card, you don’t have to pledge any asset as collateral. Your credit limit is based on your credit history and other factors.
- Student loans: Though you take out student loans for a specific purpose — to pay for your education — there is no collateral. If you default on your student loans, there are many consequences, including that your lender can take you to court.
- Personal loans: You can take out personal loans to pay for almost anything, and you don’t have to pledge any collateral. Your balance will be sent to collections and you could face penalties like a lawsuit if you don’t pay the loan.
You can also take out unsecured debt consolidation loans for a single monthly payment, hopefully at a lower interest rate. This strategy can make your debt more manageable and save money on interest payments. Secured debt consolidation loans are an alternative if you don’t meet the credit requirements for consolidating unsecured debt.
Key differences between secured and unsecured debt
Depending on your needs and goals, one of these options may be better for you. However, as a borrower, you often don’t get to choose between secured or unsecured if you need a particular type of financing (for example, a mortgage). Consider these key differences to better understand how secured and unsecured debts work.
Collateral requirements
The main difference between secured and unsecured debt is that secured debt requires collateral, while unsecured debt doesn’t. You don’t have to pledge any money or other assets to qualify for an unsecured loan. But with secured loans, you must offer one of your assets — like your home or vehicle — as collateral. If you default on a secured loan, your lender can repossess the asset.
Credit criteria
Creditors typically impose stricter credit criteria for unsecured loans since they’re riskier for them. If you have an excellent or good credit score, you should be able to qualify for unsecured loans. Lenders’ requirements vary, but you need a credit score of at least 610 to 640 to be eligible for most unsecured loans and 740 or higher for the most favorable interest rates.
If you have poor credit or no credit history, you’ll have an easier time qualifying for secured loans. Some lenders don’t have minimum credit score requirements for secured personal loans. You can use these loans to boost your credit score and become eligible for unsecured loans in the future.
Interest rates
Unsecured loans also often have higher interest rates than secured loans. Much like stricter credit score requirements, lenders use these higher interest rates to offset the risk associated with unsecured loans.
Borrowing Limits
The credit line or borrowing capacity differs for secured and unsecured loans. Lenders are often willing to offer higher borrowing limits on secured loans since they are lower risk. Unsecured personal loans typically range from $1,000 to $100,000. Most lenders won’t offer more than $100,000, and many have lower maximums of $40,000 to $50,000. For more than that, you will need a secured loan.
How to qualify for unsecured loans and lines of credit
If you’re interested in getting an unsecured loan, follow these steps:
- Check your credit score: Your credit score is one of the key factors lenders use to decide whether you qualify for unsecured loans. You’ll need a credit score of at least 610 to 640 for most personal loans, but you’ll get more competitive interest rates with a score of 720 or higher.
- Consider your budget and current loans: Make sure your new monthly payments will fit into your personal budget before you take out a new loan. Calculate your debt-to-income (DTI) ratio and try to lower it before applying for a new unsecured loan.
- Look for lenders: Shop around for lenders, including banks, credit unions and online lenders, to find the most competitive interest rates and payment terms. Prequalify online to better understand what loan terms you qualify for, but be aware that these terms aren’t guaranteed.
- Submit your application: Once you decide on your lender, gather the necessary documentation and fill out the application — you can often do it online.
If your credit score isn’t where it needs to be to qualify for an unsecured loan, you can take steps to improve it before applying. Start by learning how to remove charge-offs and remove collections to boost your score. You can also look for a lender specializing in loans for those with bad credit for a more immediate option.
Is a credit card secured or unsecured debt?
Most credit card debt is unsecured debt. The credit card company can’t repossess your assets if you don’t pay your credit card debt. Instead, your credit card company will launch collection efforts and eventually sue you to collect the amount you owe if you don’t repay the debt.
Secured credit cards are available but require a cash security deposit as collateral. In return for your deposit, the credit card company will likely give you a credit limit equal to your deposit amount. If you make a $500 deposit, for example, you can spend up to $500 on your secured credit card. Using a secured credit card could help you build your credit history and improve your credit score so you can qualify for unsecured loans in the future.
Can a credit card company sue you for unsecured debt?
A credit card company can sue you for an unsecured debt if you don’t make payments. They won’t do so instantaneously, and there’s no guarantee your credit card company will ever sue you, but it is a possibility you need to keep in mind. A credit card company will typically follow this timeline for considering collections:
- After 30 days of missing a payment, your credit card account will become delinquent. Your credit card company will contact you to arrange for payment.
- If, after 180 days, you still haven’t made your minimum payments — with added fees — your debt will go into default.
- The credit card company can either file a lawsuit against you to collect payment or sell your debt to a collection agency.
Collection agencies can also sue to collect your debt once they own it. You would receive a summons, which you must respond to before the deadline. Otherwise, the debt holder can win the lawsuit by default. In that case, the judge may rule to levy your bank account or garnish your wages and tax refunds to collect the money you owe.
Even after your credit card company launches a lawsuit, you can still negotiate with debt collectors and settle out of court. Confirm the debt details and call your credit card company — or the collections law firm managing the lawsuit on its behalf — to set up a payment plan. Remember that these calls may be recorded, and your credit card company can use the things you say against you in the lawsuit. Consult with a lawyer specializing in consumer protection for help.
Choosing what works for you
If you need a loan and you’re not sure whether unsecured or secured loans are right for you, consider these key takeaways:
- Unsecured debt requires no collateral.
- Secured debt requires an asset — like a car or home — as collateral.
- Secured debt typically has lower credit requirements and interest rates.
- Unpaid secured debt will give your creditor the right to seize your property as payment.
- You could face penalties like fees and lawsuits if you don’t pay unsecured debts. Your balance can be sent to collections.
- Secured debt allows borrowers with poor credit to improve their credit score and qualify for unsecured loans in the future.