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Unsecured -VS- Secured Debt

It is not uncommon for people to ask about the difference between unsecured debt versus secured debt and how they two types of debt may effect credit scores.

Unsecured debt is debt that is not guaranteed or “backed” by any collateral. Essentially this means that if you default on an unsecured debt there is nothing that the creditor can take back to recover their costs for non-payment of the loan. Interest rates tend to be higher on unsecured debt because there is no collateral for the creditor to seize. Credit cards fall into the category of unsecured debt. A credit card company cannot seize any of your possessions if you do not pay off the balance. Creditors attempting to collect on a delinquent unsecured debt typically turn the account over to a collection agency.

Secured debt is debt that is backed by some type of collateral such as assets or revenue from the borrower. Mortgages and vehicle loans are two examples of secured debts. If the borrow allows the loan to become delinquent, the lender can foreclose on a home or repossess the vehicle for non-payment. Because there are assets the lender can use to recoup their loss in the event of a loan default, interest rates are generally lower on secured loans.

A small portion of your credit score (about 10 percent) is based on the types of debt you carry and whether or not you have a “healthy” mix of credit types. The score takes into account if you have a mix of revolving and installment loans. Revolving loans are often the types of loans issued with unsecured debt. Your payment amount can fluctuate, or revolve, based on your account balance and interest rate. Installment loans are typically issued with secured debt. For example, if you take out a vehicle loan, you are given a set schedule of payments. Your payment and interest rate generally remain the same each month until the loan is paid in full.

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