What Is Unsecured Debt?
If you need a personal loan, you have likely stumbled across a few different options. Unsecured debt loans and secured debt loans are two of the most common types of loans individuals take out. The reason for taking out a personal loan is, well, personal. Most people are drawn to these loans to help pay for a wedding, carry out home renovations, or to get them out of a difficult financial situation.
Keep reading to learn how unsecured debt works and discover its advantages and disadvantages.
How Unsecured Debt Works
Unsecured debt is a type of loan that’s not backed by collateral. These loans are slightly more risky to the lender since the borrower doesn’t need to back the loan with assets, like a car or house. If the borrower defaults on an unsecured loan, then it’s possible that the lender can’t recover their investment.
Secured debt, a different type of personal loan, is backed by collateral. Since unsecured loans are the riskier option, lenders will seek higher interest rates. If your loan has higher interest rates, it means that over the course of the loan, your total repayment will be more expensive than other options like collateralized loans.
Types Of Unsecured Debt
There are different types of unsecured arrears, but the most common will include:
- Court judgments that haven’t yet been enforced
- Income taxes
- Student loans
- Credit card charges
- Medical bills
- Back rent that you owe
Most types of arrears are unsecured, and many people take on unsecured arrears to help them achieve their goals or get them through certain times in life. It’s important to understand exactly the type of arrear you’re pursuing since terms can vary. For example, income tax debt is unsecured until it has reached a level of delinquency that has a governmental lien on it.
Example Of Unsecured Debt
So what does unsecured debt actually look like in the real world? Let’s say you’re the borrower and you need $15,000 for emergency home repairs. After approaching different private lenders, you settle with company A, who, after checking your credit history and background, agrees to give you a loan. The loan has higher interest rates than secured loan options, but you don’t want to put up any collateral. Therefore, you take the loan from company A.
Unfortunately, after six months you have missed multiple payments and are struggling financially to take care of the loan and its obligations. The lender considers suing you, but since the loan is unsecured and thus no collateral was taken, company A decides on a different path to get its money.
After reporting your delinquency to the credit bureaus, your credit begins to suffer. This affects your ability to rent a home and even get good terms on a car lease. Next, company A hires a collection agency to handle getting the money from you on its behalf. Company A agrees to pay the collection agency a percentage of whatever is recovered from the loan.
You now have a collection agency to deal with and the mounting pressure to get your finances in order. You’ll want to make a plan and deal with the creditor.
Of course, had you met the loan repayment obligations and paid your monthly fee and interest, you wouldn’t have encountered any problems with your credit or had to deal with any creditors. When considering unsecured options, take a realistic look at your financial situation and be sure you can meet the monthly payments.
Advantages Of Unsecured Debt
- These loans don’t require collateral, so you can rest easy that your assets, like your house and car, are safe
- It tends to be more flexible than other secured options thanks to its more generous repayment options. These tend to extend from one month to several years
Disadvantages Of Unsecured Debt
This option is also subject to some disadvantages, which include:
- Due to the fact that unsecured personal loans are a more risky option for the lender, the lender will report to credit agencies, use collection agencies, or even sell the loan on the secondary market. This can have major effects on the borrower
- Higher interest rates can make getting rid of unsecured debt more challenging
No matter your reason, if you’re considering a personal loan, it’s essential to understand how an unsecured loan works. Once you fully understand the unsecured debt definition, you can understand how unsecured loans may affect you. Take a critical look at your financial health and discern what’s the best option for you. With a little research, you can be on your way to making smarter financial decisions.