If you’re among the millions of Americans with credit card bills, student loans or medical bills, you have unsecured debt. But what does that mean, and how does it differ from secured debt?
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Key points
- Unsecured debt isn’t backed by collateral
- Examples of unsecured debt include credit card bills, medical bills, payday loans, personal loans and some student loans
- Unsecured debt is lower risk for borrowers because there is no asset for a lender to seize if you can’t make your payments
- Unsecured debt is a bigger risk for lenders, so the interest rates you pay will typically be higher
What does unsecured debt mean?
Unsecured loans: This refers to types of debt not backed by collateral or any specific asset.
Secured loans: This type of loan is secured by collateral, usually the property or the asset that’s being financed.
Common examples of secured and unsecured debt
| Unsecured debt | Secured debt |
| Credit card bills | Car loans |
| Medical bills | Mortgages |
| Personal loans | Home equity loans |
| Student loans | Home equity line of credit |
How unsecured debt works
Unsecured debt is usually more expensive for borrowers than unsecured debt. That’s usually for a few reasons:
No collateral is required
Unsecured debt refers to a type of loan not backed by collateral. Collateral is an asset or property (like a car or home) that a borrower pledges to the lender as security in case they default on the loan.
In the case of an unsecured loan, the lender extends credit based on the borrower’s creditworthiness, income, and other factors, without requiring any collateral.
Since no collateral is involved, unsecured loans typically carry higher interest rates than secured loans.
READ MORE: Are you drowning in debt?
Higher risk for lenders
Because the lender’s risk is higher, obtaining an unsecured loan generally requires a stronger credit history and a good credit score. Lenders assess your ability to repay based on your income, employment history, credit history and other factors. In case of default, the lender may take legal action to recover the loan amount, but they do not have the direct right to claim specific assets as they do with secured loans.
For example, if you fail to repay your student loans, you will still have your degree. And if you fail to pay your credit card bills, the items you purchased with the credit card won’t be confiscated. In comparison, if you fail to make your car payments, the lender will likely repossess your vehicle.
Both types will affect your credit score
Both unsecured and secured loans are reported to the three major credit bureaus — Experian, Equifax and TransUnion. This means that if you pay your bills on time as scheduled, they will help your credit score. But if you routinely make late payments or skip payments altogether, both types will hurt your credit score.
Pro tip: Both unsecured debt and secured debt require a solid credit history for eligibility. If you have bad credit, a secured credit card will probably be your best bet to rebuild your credit so that you can qualify for other forms of loans.
Lower risk for borrowers
Taking on unsecured debt is common, with minimal risks if you manage it properly. According to the Federal Reserve Bank of Atlanta, 77% of Americans over 18 have at least one credit card.
The problem starts when borrowers take on more debt than they can afford, and they only make minimum payments each month, repeatedly make late payments or stop making payments altogether. That’s when it starts to hurt your credit score.
However, there is no asset to seize, so if you get behind on payments, your home and/or car are not at risk.
According to findings from Chase, one in five credit card users regularly skip payments, and 43% only make the minimum payment each month.
Unsecured debt vs. secured debt
Because secured debts are attached to assets, borrowers typically pay lower interest rates. But the risk for borrowers is significantly higher.
Here is a comparison of some of the most common types of secured and unsecured loans:
| Home loans (secured loans) | Auto loans (secured loans) | Personal loans (unsecured loans) | Credit cards (unsecured loans) | |
| Average annual percentage rate (APR) | 7% to 8% | As low as 3% up to 20%, depending on credit score | Anywhere from 5.91% to about 35.99%, depending on the loan amount and borrower’s credit score | 14% to 26%, depending on credit score |
| Loan term | Up to 30 years | 72 months | 1-20 years | Indefinite |
| Consequences of late payments | Possible foreclosure and credit score damage | Repossession and credit score damage | Credit score damage, potential legal action | Credit score damage, potential legal action |
| Credit score requirement | Around 620 | 660 or above to get the best interest rates | 610, though a few lenders have no minimum credit score requirement | 670 to qualify for the best offers. |
You will still need to make your minimum monthly payments in each case. Both will appear on your credit report, and failure to repay either type of loan will hurt your credit score.
Pro tip: Though the repayment terms and loan amounts of both types of debt are similar, real estate loans and car loans traditionally have lower interest rates than unsecured personal loans or credit cards. In both cases, though, you’ll pay higher interest rates if you have bad credit.
READ MORE: Best personal loans for bad credit borrowers
Secured credit cards vs. unsecured credit cards
Borrowers with poor credit may not qualify for a traditional unsecured credit card. In those instances, a secured credit card is an excellent option to help reestablish creditworthiness.
Secured credit cards are designed for consumers with poor credit. They require a security deposit. Your credit limit will be the same as the security deposit you provide. If you exceed that limit, your charges will be declined. On-time payments will be reported to the three credit bureaus, and once you have boosted your credit score a bit, you can ask the issuer to transition you to an unsecured card.
READ MORE: Everything you need to know about secured credit cards
Unsecured credit cards are a preset revolving line of credit with no security deposit. If you pay your bill in full before the due date, you will pay no interest at all. Unfortunately, many Americans don’t do this, and families face record amounts of credit card debt.
Pro tip: Getting a secured credit card is not the same as being listed as an authorized user on someone else’s unsecured credit card account, though both options can help you build credit and try both simultaneously.
Secured vs. unsecured loan: Which is better?
The type of loan that will work best for you will depend on your financial situation.
| When a secured loan may be better | When unsecured loans may be better |
| You need a longer repayment term | You need money fast |
| You have collateral | You don’t have property to use as collateral |
| You need to borrow a significant amount of money | You need to borrow a small amount of money |
| You know you can make the payments | You aren’t sure you can make the payments as scheduled |
| You don’t mind placing your assets at risk | You don’t want to risk losing your assets |
Unsecured loans don’t have to be expensive
Though unsecured debts tend to have higher interest rates, there are ways to avoid paying any interest at all. For example, if you make your loan payments in full each month, no interest will accrue. Or if you have good credit, you may qualify for a balance transfer offer with a 0% introductory rate.
Although lenders typically charge higher interest rates on unsecured debt, there are ways to get around this. For instance, you may qualify for a 0% introductory rate. Another way to bypass the higher interest rates would be to pay your credit card bill in full each month. Unfortunately, more than half of Americans carry a balance from month to month on their credit cards.
What happens if you don’t pay an unsecured debt?
The damage for failing to repay secured debts is fairly straightforward. You could lose your car or your home.
However, the consequences of defaulting on unsecured debt are a little less obvious. Although there are no assets for creditors to seize if you skip loan payments, there will be other serious consequences. First, you’ll rack up late fees. Next, your debt will be sent to a collection agency, and eventually, after a few months of missed payments, your debt will be charged off.
Pro tip: Each of these will damage your credit score. Payment history accounts for 35% of your total score, and a charged-off debt could knock your score down as much as 200 points. It will be difficult to qualify for additional loans until you’ve repaired your credit.
Depending on your lender and the loan type, you could end up in court if debt collection efforts fail. Though you won’t go to jail for failing to repay an unsecured loan, a court could order wage garnishment or place a lien on your property, and your assets could be at risk of seizure. Which assets are at risk will depend on state laws.
READ MORE: How to get your debt under control now
How to get rid of unsecured debt
You have a few options if you’re stuck with multiple unsecured debts and struggling to make several minimum monthly payments. These include:
READ MORE: Top debt relief programs
The bottom line
Unsecured debt isn’t necessarily bad, but it is pervasive. It’s relatively easy to get and doesn’t require collateral, making it accessible for borrowers with little credit history or those who lack the assets to secure a major loan. Though the interest rates are higher, the lender assumes more risk. This means that if you can’t make your payments, you won’t have to worry about car repossession or home foreclosure.
However, that doesn’t mean you are in the clear. There are still severe repercussions if you fail to make payments, including credit score damage and wage garnishment. If you’re struggling, it’s best to take action now because your debt situation will only worsen as interest accrues.
