Secured debt vs. unsecured debt: What you need to know

If you’re borrowing money — whether you’re doing so by using a credit card or taking out a personal loan — you’re creating debt that you have to repay, usually with interest. But there are a few different types of debt, including secured and unsecured debt, and it’s important to know the difference between the two. Here’s how you can tell the difference between secured and unsecured debt, and information on why it matters.

What is secured debt?

A secured debt is a loan or line of credit backed by some type of collateral that is of equal value to what you’re borrowing. Secured credit and debt may include:

• Mortgages
• Car loans
• Home equity loans or lines of credit
• Secured credit cards
• Secured business loans

“If you don’t make your payments, lenders can seize an asset that serves as collateral,” says Katie Ross, executive vice president at American Consumer Credit Counseling.

Secured debts have an upside, however, says Connor Brown, personal finance expert and founder of After School Finance.

“Secured debt generally has a lower interest rate, because the lender has a source of collateral if you don’t make your payments,” says Brown. “Mortgages, home equity loans and car loans usually have low rates because they’re backed by collateral with reasonably predictive values.”

If you’re using a vehicle or home as collateral, the lender can make an accurate guess about what its value will be over time. Depending on your credit history, that could translate to lower interest rates and lower monthly payments for you.

What is unsecured debt?

Unsecured debts aren’t backed by collateral, so there are no assets for the lender to seize if you default on payments. There’s still a promise to pay on your part, but you don’t have to put your car, home or another asset on the line to get a loan or line of credit.

Unsecured debts may include:

• Most credit cards
• Personal loans
• Lines of credit
• Federal student loans
• Private student loans
• Peer-to-peer loans
• Medical debts
• Small business loans

If you default on any of these types of unsecured debt, you won’t risk losing any collateral. But there can be other consequences, Ross says, including being subject to debt collection efforts, being sued in civil court and having your wages or bank accounts garnished.

You might run into those things if you default on an unsecured credit card debt or line of credit, a personal loan, private student loans or medical bills. If you’ve defaulted on federal student loans, the government can also take some or all of your tax refund to help pay back what you owe.

Secured debt vs. unsecured debt: Which is better?

If you’re wondering whether it’s preferable to owe secured versus unsecured debt, the answer isn’t so clear-cut.

“Secured debt is used for many different reasons and isn’t necessarily bad,” says Dawn-Marie Joseph, founder of Estate Planning & Preservation in Williamston, Michigan.

For example, a secured loan is a necessity if you’re getting a mortgage to buy a home. And, Joseph notes that in some instances, you can use secured credit cards, loans or lines of credit to repair poor credit scores.

Likewise, certain unsecured debts, such as federal student loans, are typically seen as “good” debt because they’re used to make an investment in your education. Meanwhile, credit card debt — which typically has a high interest rate — is generally not considered beneficial.

What makes one debt “better” than another may not hinge on whether it’s secured or unsecured. Rather, it generally hinges on factors that include:

• Interest rates and fees
• Annual percentage rate
• What it’s being used for
• Whether it positively or negatively impacts your finances

And, in the end, what really matters most is typically how you handle each type of debt you owe.

“Regardless of the type of debt, if you don’t make your payments, your credit score will be adversely impacted,” says Brown.

For FICO credit scoring, the longer an account goes late or unpaid, the worse the impact is on your credit score. Negative information, such as late payments, missed payments, collections and charge-offs, can remain on your credit report for up to seven years.

Managing secured debts vs. unsecured debts

If you have multiple debts, it’s helpful to have a plan for paying them off. And, the best payoff plan for you might depend on the type of loan and interest rate. Your financial situation could also play into your decision.

There are a couple of different methods you can use to help you pay down debt as quickly as possible. If you’re in a tight spot financially, you may want to first pay the debts that have an asset attached to them, such as your mortgage or auto loan. Keeping current on those payments can help you avoid losing your home or car.

Missing payments on unsecured debt could hurt your credit, but there’s no immediate risk of losing any assets. If you’re concerned about staying on top of your debt, remember that your lenders and issuers may have options to help.

For example, you may be able to get a temporary forbearance on mortgage payments, put your federal student loans into deferment or forbearance, or apply for a hardship program with your credit card company. These can all be useful in managing secured and unsecured debts while keeping your credit intact as much as possible.

And even if your finances are on solid ground, think carefully about adding to your debt load.

“Do your research before opening up new credit cards, getting a new car loan, taking out student loans, et cetera,” says Ross. “Understand the terms of your loan and what the interest rate is to make sure you can actually afford the payments.”

Bottom line

A simple way to tell the difference between secured and unsecured debt is to look at what’s backing it. If a valuable asset is tied to the debt, it’s secured. If the debt is only backed by your name and credit score, then it’s unsecured.

Understanding how to prioritize secured debt versus unsecured debt helps you make more informed financial decisions. Always remember that defaulting on secured debt could result in losing the asset backing it, but defaulting on unsecured debt could mean a devastating hit to your credit score.