WTFinance is unsecured debt vs secured debt?

I was thinking about applying for a loan, and a friend asked about my “unsecured” and “secured” debt. That stopped me cold.

I paused for a moment and thought to myself, isn't all debt the same? I realized I needed to understand the difference. If you have felt the same way, it’s ok.

Let’s talk about what these terms mean—and how they work.  

What is unsecured debt? 

“Unsecured,” as it is used here, doesn’t mean risky or unsafe. Unsecured debt just means a loan that you qualify for based on your creditworthiness. It doesn't require that you pledge something—like a car or house—to back up, or "secure" the loan.  

To decide whether to offer you an unsecured loan or line of credit, lenders will look at your: 

• credit history

• credit score

• employment history

• debt-to-income ratio (DTI) 

Common forms of unsecured debt found in the wild include: 

• most credit cards 

• unsecured personal loans

• student loans 

• personal loans or lines of credit 

• medical bills 

What is secured debt? 

Secured debt, on the other hand, is any loan that requires you, the borrower, to pledge something valuable (aka “collateral”) as a guarantee that you’ll repay the loan. This gives the lender a Plan B in case you aren't able to keep up with your payments. (Life does happen, and unexpected events can toss a wrench in anyone's money situation.) If you were to default, the lender has the right to sell the asset to recover the money you owe them. 

Common forms of secured debt include: 

• mortgages 

• car loans 

• home equity loans 

• home equity lines of credit 

• boat loans 

• secured credit cards 

• secured personal loans 

Comparing secured and unsecured debts: pros and cons

No loan is perfect for everyone. Let’s look at the pros and cons of both options.

Unsecured debt pros

• Can borrow money without putting up any collateral

• Simple application process 

• Speedy funding times (1-3 business days) 

Plus, an unsecured personal loan can be a good way to pay off credit card debt. An unsecured personal loan could allow you to consolidate multiple debts down to one—and potentially lower your interest rate, too.

Unsecured debt cons

• Higher interest rates compared to secured loans

• Can be harder to qualify for

• The best terms and rates are reserved for borrowers with excellent credit

Secured debt pros

• Typically lower interest rates compared with comparable unsecured loans 

• Usually easier to qualify for

• Often have higher loan limits compared to unsecured options 

Secured debt cons

• You’ll have to offer a valuable asset as collateral, and if you default, the lender can seize your house, car, etc.

• Some secured loans can only be used for one thing (i.e., you have to use your car loan to buy a car)

• Can take longer to apply and process an application 

Secured debt versus unsecured debt: Which is right for you? 

The type of financing that's best for you depends on your unique, individual situation. 

Here are some questions that can help you choose:  

• How much financing do I need? 

• What am I using the loan for?

• How long do I need to pay off the debt? 

• How quickly would I like to receive the money? 

• Do I have an asset to offer as collateral?

Knowing the difference between secured and unsecured debt can help you land on a loan or borrowing option that works for you, based on your financial situation and goals. Which will help you feel more…secure.