To best define unsecured debt, consider the opposite -- secured debt. A secured debt is a loan guaranteed with an asset or collateral. The lender places a lien against your asset, giving him the right to take it if you don't pay the debt. Unsecured debt is a loan given without the benefit of collateral or security for the lender.
Secured Debt
Examples of secured debt include your mortgage, for which your home is the collateral, and your car loan, secured by your vehicle. If you should declare bankruptcy, the lender can repossess your vehicle or foreclose on your home. The lender can then recover monies owed by selling either asset at auction or hold the property until you reconcile the debt.
Unsecured Debt
Most credit cards are examples of unsecured debt, as well as money owed to doctors, hospitals and student loans. The lender in these cases has few options for collecting outstanding debt if you fail to pay. In the event of a bankruptcy, the court pays your secured creditors first from proceeds obtained through the sale of your assets. Unsecured creditors will have claim to any remaining amount.
Significance
Since secured debt presents less of a risk for the lender, the interest rate for a secured loan is usually much lower. The lender knows she can sell the property to recoup the money loaned. The only thing backing an unsecured loan is your credit-worthiness, your income, and your promise to repay, which means a much higher interest rate, especially if you have a low credit rating.
Priorities
If you are struggling to pay off your debts, it is best to pay your secured debts first. Failure to pay unsecured debts is unlikely to result in the loss of your home, vehicle or other substantial assets. If you fail to pay secured debt, the lender may pursue litigation in court to obtain a money judgment against you.
Consolidation
A viable alternative for lowering high interest rates and monthly payments on unsecured loans is debt consolidation. The easiest way to consolidate unsecured debt may be through a refinance of your current mortgage or attainment of a second mortgage or home equity line of credit. Typically, you will have a much lower interest rate on these types of loans, and you can enjoy some tax benefits not available with most unsecured credit.
Bankruptcy
Filing for personal bankruptcy is the choice of last resort for reconciling your unsecured debts. A bankruptcy can significantly lower your credit rating and remains on your credit report for seven to 10 years. Whether you file for Chapter 7 or Chapter 13 bankruptcy, either can discharge unsecured debts, stop repossessions or foreclosures, prevent wage garnishment and provide exemptions, which may allow you to keep certain assets.
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