What is Unsecured Debt?

Unsecured debt refers to debt that is not tied directly to something of financial value (an asset). For example, part of the process of purchasing a home is getting a loan from a bank for the portion of the purchase that you will need to pay for over time (finance). The loan that you and the bank agree to is backed (secured) by the value of the home itself.

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So, what makes this type of loan “secured”? If you don’t repay the loan to the bank according to the agreed terms, the bank can legally foreclose on the home in order to offset the value of the payments it did not or will not receive from the borrower. Normally the bank will then sell the home and use the proceeds from the sale as compensation for the lost loan payments. This is what makes the bank’s loan “secure”. They have a financial recourse built into the loan that allows them to recover their money if the loan should go bad. Foreclosures can sometimes be averted through a loan modification, which allows a borrower to receive more favorable loan terms than were originally agreed upon without having to refinance the loan through another lender. This is particularly important when the borrower is unable to qualify for refinancing due to poor credit, loss of income or a drop in the value of the home.

Another example of a secured loan is a loan for the purchase of a car. In this scenario, the car is the asset tied to the loan, and if the loan isn’t repaid as agreed, the bank can repossess the car and sell it to cover the lost loan payments. Because of this security, the bank is able to lend money at a lower interest rate than if they had no specific financial recourse tied to an asset.

But wait a minute. What about a credit card? The money I borrow when I pay for something with a credit card isn’t tied directly to an asset, is it? No, it isn’t. The bank issuing the credit card has no recourse to a particular named asset in case it needs to recover for payments that aren’t made as agreed. You merely made a promise to make the required payments when you signed the credit card agreement. This is what is called unsecured debt.

Types of Unsecured Debt

Credit Card Debt
Department Store Cards
Oil/Gas Credit Cards
Medical Bills
Personal loans
Overdue Rent
Past Due Utility Bills
Local Merchants
Collections / Autos in Repossession

Because of the higher risk involved with unsecured credit debt, banks charge higher interest rates and fees to offset the losses incurred on bad unsecured debt loans. When consumers get in trouble by overspending on unsecured debt at high interest rates, they often seek relief by exploring various debt solutions.