The difference between a secured debt and an unsecured debt is simple. A secured debt is one that is backed by actual collateral. This collateral can be a dwelling or a car or anything that has definite value. On the other hand, an unsecured debt is one that is contractual. The borrower simply signs a document that says that the debt will be paid back within a certain time and within certain conditions.
There are three kinds of unsecured debts. The first is an unsecured business debt, in which the business is responsible for repaying the loan. . The second is a private unsecured debt, which means that the person taking out the loan is responsible for repaying the loan. Lastly, there is an unsecured business debt with private assurance. If the business cannot repay the loan, the individual who took out the loan is responsible for the repayment.
Unsecured debts function as short-term loans based upon an individual's creditworthiness. They are not designed for a long-term payback, and if an individual does not have good credit, the interest rate might be higher, since there is a greater likelihood that the debt might not be paid back. On the other hand, a secured loan will have a longer payback period, since the borrower has a physical asset that can be used to pay off the debt if the borrower does not meet the terms of the contract. The most common example of an unsecured debt is using a credit card.
Video of the Day
If an unsecured debt is not paid back or if the payments are late, the lender can increase the interest rate and charge penalties, if those conditions are spelled out in the contract. In addition, the late payment or the debt default can be reported to credit bureaus, affecting an individual's credit rating.
Declaring bankruptcy will not necessarily absolve an individual from having to repay an unsecured debt. A court can order assets to be sold to pay off the unsecured debt, depending upon the circumstances. On the other hand, the court can find that the lender does not have to pay back the debt, depending upon the circumstances.
If an unsecured debt is not paid back, the lender has the right to take the borrower to small claims court, where the borrower might be found liable for the debt and required by the court to pay it back to the borrower.
If an unsecured debt is not paid back, the lender will sometimes engage a collection agency to retrieve all or part of the debt. When a debt is turned over to a collection agency, it is usually reported to credit reporting agencies.
- Andrew Bret Wallis/Brand X Pictures/Getty Images