Even though there are many different types of debt, there are two main forms: secured debt and unsecured. Most of the debt you have will fall into one of these two categories. Each one of these will handle your debt in very different ways. Once you know these differences, it can greatly help when it is time borrow money, pay off debts or protect your assets.
A secured debt is a one that is tied to an asset. This asset is then collateral for your debt. If as the borrower you stop making payments on the debt, the lender will have the right to take possession of the asset. Once that lender takes over the asset, it is likely to be sold so the funds can cover the remaining debt which is owed. However, if the sale of the asset does not cover the remaining debt, you will be responsible for that balance. If you are not able to pay that remaining balance, the lender can pursue that money through legal means.
The best examples of secured debt are home and auto loans. With each of these, both the automobile and the house would be used as the collateral for the loan. If either of these loans defaulted, it would result in foreclosure of the house or repossession of the vehicle. Other forms of secured debt include a title loan where you are not considered the owner of the asset until the full debt has been paid.
The reason it is called unsecured is because the debt does not need to be backed up with collateral. If you are unable to make payments on this type of loan, typically the assets you accumulated with the loan money cannot be sold to pay off the debt. However, the lender can take actions against you to get payment for the debt, these may include:
- Have a debt collector pursue you
- Garnish your work wages
- Taking one of your assets
- Have a lien placed on your assets
The most common forms of unsecured debt are credit cards, medical bills and student loans. Child support can even be considered unsecured debt.
The other thing you will need to take into consideration for defaulting on an unsecured debt is that it will be reported to the credit bureaus where it will appear negatively on your credit report. With a lower credit score, you will have a harder time getting any type of loan.
A secured debt is usually for something that is necessary in your life, like your home. It is important to prioritize your bill paying to secured debts since losing things like a home or car can be devastating. However, this does not mean that you should not take unsecured debt seriously. Defaulting on unsecured debts can have long lasting effects on your credit and ability to secure any type of loan in the future.