What Is Unsecured Debt?

Unsecured debt is a loan not tied to an asset, like a home, automobile or investment. This means that if a borrower defaults on the payment or fails to repay the loan, the lender cannot seize their assets as compensation. However, this also leads to more risk for the lender, which is why unsecured debts often come with higher interest rates and trickier terms. Despite these downsides, unsecured debt also gives you access to debt relief options, such as debt management, debt consolidation and debt settlement.

While unsecured debt can be useful, it’s essential to understand its risks. Learn more about what unsecured debts are, how they compare to secured debts and how to manage them properly.

Unsecured debt is a type of loan not backed by an asset or collateral. Because these loans aren’t backed by collateral, the lender is not entitled to claim your assets if you cannot repay your loan.

While unsecured debts protect your assets in this way, they don’t waive your responsibility to repay your loan. Lenders can penalize you in other ways if you default on payments. For instance, lenders can hire debt collectors, file a lawsuit against you or report your missed payments to credit bureaus — all of which can negatively impact your finances.

If you can’t repay your debts, you have the option to default on payments and avoid a lawsuit by filing for bankruptcy. However, this can severely impact your credit score and prevent you from securing loans in the future.

Unlike unsecured debts, a secured debt is a loan backed by collateral. Your collateral can be your home, car or something related to your business, such as your inventory. If you default on a secured loan, lenders have the right to seize the asset you put up as collateral. While this can be intimidating, secured debts often come with lower interest rates and flexible terms in exchange.

There are many types of unsecured debt meant for different purposes. For instance, credit card debt, student loans and medical loans are just a few of the many types of unsecured debts that an eligible borrower can access.

Review the different types of unsecured debts below to determine which one may be right for your circumstances.

• Credit Card Debt: Credit card debt is a type of revolving loan that gives you access to a credit limit that can be spent and repaid in a cycle. You can use it to fund everyday purchases or unexpected expenses.
• Personal Loans: Personal loans can be used for almost any purpose unless specified by the lender. While they are sometimes marketed under different names — such as wedding loans or home improvement loans — they all operate in essentially the same way.
• Student Loans: Student loans are funds dispersed for educational costs. These can be used for tuition fees, books or other expenses related to schooling.
• Medical Loans: A medical loan is a type of loan meant to pay for medical care, which can allow you to get the care you need without having to wait until you can afford it.
• Business Loans: Business loans are meant for business expenses. They can be used to pay for any business operating expense, such as inventory or wages, as needed.

Unsecured debt can be a valuable financial tool if managed correctly, but it’s best to understand its advantages and disadvantages before making any decisions. After all, like all types of debts, unsecured debt comes with its fair share of risks.

For instance, even if lenders cannot seize your assets, defaulting on payments can still impact your credit score. Lenders can report your missed payments to credit bureaus, affecting your access to loans in the long run.

At the end of the day, borrowers are in charge of how much an unsecured debt can benefit them. For instance, choosing only to borrow what you can repay can go a long way in helping you address your needs and financial situation. If you make your loan payments on time, you will ultimately impact your credit score positively. This can lead to lenders giving you more favorable terms in the future, such as a lower interest rate.

It is not uncommon to have both secured and unsecured debts simultaneously, such as a mortgage and credit card debt. However, when it comes to prioritizing repayment, unsecured debts should always come first.

Even though you may have more to lose with a secured loan, unsecured debt has higher interest rates; addressing those right away can create more room to pay for low-interest debt faster and improve your credit score significantly.

Bankruptcy is also a way to address unsecured debt if you are unable to repay it. However, remember that this can negatively impact your credit score and keep you from accessing new loans and lines of credit in the future; with that in mind, it’s best to use this option as a last resort.

Although unsecured loans aren’t backed by collateral that lenders can seize, it doesn’t mean there aren’t other consequences. Lenders can charge you a hefty late fee if you fail to make payments on time, which can increase your minimum payment when your bill is next due. If you set up automatic payments and don’t have enough funds in your account, you may also be charged an overdraft fee by your bank.

These fees can make it even more challenging to repay your debt and may lead to a snowball of fees and interest that can result in bankruptcy; that’s why it’s important to ensure you pay at least the minimum payments on time.

Understanding what unsecured debt is can help you determine if it’s the right type of loan you want to take. Review some of the most frequently asked questions about debt below.