What Is Unsecured Debt?

Did you know there are many variations of debt?
What is unsecured debt
Article Overview

Have you ever heard of unsecured and secured debts? What do they mean? How do you get them? Are they beneficial for you? You can find answers to all your questions on these type of debts below.

To help you understand your debt better and find your way to financial freedom and then success, check out our other helpful articles.

What Is Unsecured Debt?

Unsecured debt is generally referred to as monies borrowed without the requirement of collateral to secure the debt. The way it works is that a creditor extends the funds based solely on the creditworthiness and a promise to repay by the borrower.  The most common type of unsecured debt is credit card debt. The credit card issuer grants an overdraft based on the credit score of the user. If you fail to repay your credit card debts, there will be interest on the amount owed which further makes it difficult to settle the debt. Other types of unsecured debt include Personal Loans, Overdrafts, Payday Loans, Lines of Credits, Student Loans, and Department Store Cards.

Advantages Of Unsecured Debt?

1. No Collateral

This is the number 1 advantage of an unsecured loan. The fact that there is no obligation on the part of the borrower to provide an asset to secure the loan is what makes an unsecured loan desirable for most people. This gives the borrower access to the funds without having to look for an asset to use as collateral.

2. Less Risky

An unsecured loan is typically less risky because you are not using an asset to secure the loan. There is no risk of losing the property you have used as collateral in case you default. This is particularly favourable to a person who might have to use his/her asset as collateral. Unsecured loans are based on trust.

3. Quick Application Process

Most unsecured loans have an easy application process. A good example is a credit card account. A major reason for the easy process is the absence of collateral which eliminates the need for documentation.

4. Your Property is Safe

Asides from the fact that you do not need to have collateral to secure a loan, the lender also does not have the right to take your property to offset the loan. At least, not right away. Unsecured loans are extended on the credit worthiness of the borrower. Therefore, there may not be a need to take possession of the borrower’s property because he/she has defaulted.

Disadvantages Of Unsecured Debt?

1. High Risk Higher Interest Rate

In an unsecured loan, the lender takes all the risk which naturally means that the interest rate will be high to cover for the risk and the absence of collateral. This may not be favourable to the borrower because it makes it more difficult to pay back.

2. Stricter Condition To Qualify

Due to the nature of unsecured loans, the criteria for qualification is usually stringent. They are given to people who the lender is certain will be able to repay the loan. The credit worthiness of the borrower is a very important criterion. The borrower must also show that he/she has a stable job and a steady income that will be able to repay the loan over a specific period.

3. Limited Funds

Due to the high risk involved in an unsecured loan, lenders are usually not predisposed to extend a high amount of funds as a loan. The amount extended may not sufficiently cover the need of the borrower.

4. Probability of Incomplete Repayment

There is always the risk that the lender may not recover the full money borrowed in the event of default from the borrower. This is the peculiar thing about an unsecured loan. There is no asset to be that can be used to replace the money borrowed. A lender of an unsecured loan must always be ready for this eventuality.

5. Controversial Ending

Sometimes, an unsecured loan transaction may lead to litigation or a controversial end. The fact that there is no collateral and the lender does not have the right to seize the borrower’s property when there is a default may lead to controversy. A lender may extend funds to a person he/she thinks is creditworthy, but turned out to be wrong. Getting a repayment of the loan may be difficult, especially if the borrower is not being honest. This may lead to threats, controversy and sometimes litigation.

What Is Secured Debt?

Secured debt is the opposite of unsecured debt. In other words, when you take a secured loan, you will be required to provide collateral to guarantee the loan in case of default in payment. When there is a default, the creditor can begin a process to seize the asset used as collateral to offset the loan. The most common example is a mortgage. A mortgage is usually secured against the value of your home and where there is a default, the mortgage provider has the legal right to repossess or foreclose the property in order to recoup the credit extended. Other types of secured loans include car loans and bank loans.

Advantages Of Secured Debt?

1. Higher Borrowing Limit

The provision for collateral in a secured loan transaction allows for a higher credit facility from the lender. This is because the asset used as collateral must have been assessed and concluded that it is up to or more than the value of the credit extended. This will benefit the borrower and also put the lender at ease.

2. Low-Interest Rate

The collateral provision in a secured loan makes it possible to have a low-interest rate. Lenders are always predisposed to extending credit with low-interest rates once you provide an asset as collateral. A low-interest rate will make it easier to repay the loan on time. The collateral provision in a secured loan is usually to the advantage of the borrower.

3. Lower Risk

For the lender, extending credit for a secured loan has a lesser risk because of the provision of collateral by the borrower. The lesser the risk for the lender, the higher the credit limit for the borrower. It’s a win-win. It also accounts for the low-interest rate.

4. Longer Repayment Period

A secured loan also gives the opportunity for a longer repayment period. Because the credit has been secured with an asset and it also has a low-interest rate, lenders can afford to give the borrower an extended period to settle the loan.

Disadvantages Of Secured Debt?

1. Loss of Collateral

There is usually the risk of losing the asset put down as collateral in the event of a default. In a secured loan transaction, the lender has the legal right to take possession of the asset used as collateral in the event of default of repayment. The lender also has the right to hold on to the title of the asset until the loan is repaid.

2. For Specific Purposes

Secured loans are usually better suited for a particular project, such as the acquisition of a real estate property, or a major business transaction.

3. Valuable Asset For Collateral

When taking a secured loan, a valuable asset is usually required as collateral. Such asset must be equal in value or more than the value of the loan. This sometimes makes it difficult for a borrower who does not have valuable property to use as collateral.

How To Get Out Of Debt: 3 Ways

Debt is not an easy hurdle to get over. The best advice anyone can get is to avoid debt if possible. Where you find it impossible to avoid debt, it is advisable to have a plan for getting out of it. What makes debt more difficult to repay is the interest rate. Paying a debt with an interest rate means that you most likely will be paying more than you borrowed, especially if you do not pay it back on time. Here are 3 ways you can get out of debt as soon as possible.

1. Revisit Your Budget

If you already have a budget that sets aside a specific amount to service your debt, you may have to reconsider the budget. This is so that you can adjust the minimum payment you have set to satisfy your budget. Paying more than the minimum will save you money on the interest and enable you to repay the total debt on time. This is one method you can try to help you get out of debt faster.

2. Debt Snowballing

Asides from paying more than your minimum payment, debt snowballing is another method you can employ to help settle your debt faster, especially if you have multiple debts. The way this method works is that you will divert all your attention to your smallest debt. After repaying that, you can focus your attention on the next smallest debt. This allows you to pay up your smallest debt and move to the next. It is a snowballing method that will help get rid of your debt quickly and also give you a sense of accomplishment as you settle your debts gradually.

3. Commit Your Extra Cash

You may have a budget for paying up your debt but there will be times when you come across extra cash. Beit from a remote job, a side hustle, cash gifts, inheritance, work benefits, or tax benefits. It is advisable that you divert the extra cash into paying your debt so that you can get it over with. If you do not want to spend all your extra cash on debt, you can split it 50-50 while you use the rest for something fun or you save it.

FAQ

Unsecured debt is any kind of debt which did not require you to put down a collateral. For example, credit cards are considered unsecured debt. 

If debt is unsecured, that means you did not have to offer any collateral to borrow the money. 

Unsecured debt in Canada is any kind of debt where you did not need to offer any collateral to the lender in order to borrow money. 

Unsecured debt is better because it does not require you to put up any collateral to borrow the money, so you are not at risk of losing your assets right away.  

Article Overview

Find The Right Advisor For Your goals

Is someone looking after your money?

RightFit curates the best financial advisors out there and connects you with them so that you have the right money managers in your corner.

Written by:

Jim Pan, CFP, MFA-P

Jim is a dedicated, fee and advice only independent Certified Financial Planner with a focus on supporting healthcare business owners during their crucial growth phase. His expertise lies in offering comprehensive solutions to minimize taxes while embracing a holistic approach. With a career spanning back to 2010, Jim has established a strong presence in the financial industry. He proudly holds a range of designations, including Certified Financial Planner (CFP), and Master Financial Advisor - Philanthropy (MFA-P). He is currently pursuing additional designations and qualifications to better serve his clients and community. Beyond his qualifications, Jim is a member and an esteemed participant in the Million Dollar Round Table (MDRT), an exclusive global association comprising the top 1% of financial advisors. Jim's commitment extends to the community, where he spearheads numerous charitable fundraising events and plays an active role in enhancing the well-being of others. Additionally, he has contributed significantly by serving on the board of the Canadian Mental Health Association in Vancouver. Currently, he volunteers with Junior Achievement of British Columbia (JABC) to present personal finance topics to youths.

Related Articles

What is a locked in RSP
  • Investment ·

What Is A Locked-In RSP?

The Registered Retirement Savings Plan (RRSP) is a popular choice for many Canadians who’re saving for their future. Other than regular RRSP, you may have…
Want To Become A millionaire?

5 Ways of Thinking That Will Make You a Millionaire!

Discover the proven strategies that have helped hundreds of individuals achieve millionaire status. In it, you will find the five mindsets that can catapult you to millionaire status and unlock the secrets that can revolutionize your financial journey.