When it comes to borrowing money, there are many forms. It can be as complex as a boring instrument like subordinated convertible debenture to as simple as an undertaking a deal with the handshake. For convenience, the types of debt can be categorized in to secured and unsecured debt.
Essentially, the difference between the two is simple. A secured that is taken against collateral and a secured that is not. Collateral is an item that is offered as security against the loan taken and the debt created. Upon the failure of repayment, the lender can sell off the collateral to make up for the loan given to the borrower.
Determination of the debt is secured or unsecured is vital because that develops the cost of the loan. It also decides the strategy of repayment and also whether or not credit is available to be taken.
What is a secured debt?
The definition includes the borrower putting up collateral against the money borrowed in the custody of the lender. Repossession of the collateral is an essential component under security and can be of any type such as a vehicle, equipment, securities, cash, and even real estate.
Common forms of secured loans are home equity loans, home equity lines of credit auto loans, and mortgages.
The term ‘secured’ in the secure debt stands for the security offered by the collateral.
What is unsecured debt?
Credit cards and lines of credit are good examples of unsecured loans where money is borrowed without any collateral. It is based on the guarantee of promise and transparency. The level of risk on the lenders is not secured because of the absence of collateral but can assess the same by looking at the borrower’s creditworthiness. This process involves checking borrowers’ credit history and the terms of repayment in previous contracts.
Membership contracts for gyms, clubs, and other service providers are also under secured debts as the promise to pay a monthly membership is for the length of the contract only.
Comparative study between secured and unsecured debt
- Unsecured debt repayment is flexible depending on terms of repayment when compared to secured debt.
- The application process to acquire an unsecured debt is smoother when compared to the application to acquire a secured debt.
- Secured debt has a higher credit limit compared to unsecured debt.
- Failure of payment of unsecured debts negatively impacts the credit score of the borrower but not in the case of secured debts.
- The acquisition of a secured loan is easier when compared to a secured account because of the elaborate process involved in checking the creditworthiness of the borrower.
- Secured debts also provide tax benefits such as on mortgages and the advantage of tax can be taken in for deductions of interest payments. This is not available for unsecured debts.
At the end of the day, both categories of debts require payment on time sticking to the terms and conditions but one comes with heavier penalties if any discrepancies arise. It is essential to understand the terms and conditions of the fine print that needs to be before entering any debt-related contract and the history of the lender should also be given attention to.