Secured vs. unsecured debt

What is secured debt?

Secured debt is a loan or credit line that is “secured” to an asset you own. If you default on your payments, the lender can seize your asset and sell it to settle your debt obligations. The most common types of secured debt include auto loans, home mortgages and home equity lines of credit (HELOCs).

Lenders usually see secured debt as lower risk than unsecured debt because they can use the value of your asset to back the loan. Secured loans generally have lower interest rates than unsecured debt, but there’s a higher risk of asset loss if you can’t keep up with payments.

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Pros and cons of secured debt

Secured debt makes sense if you’re financing a new car and want the lowest rate possible. It can still be risky — and is not the best idea for just cashing out your asset equity to spend or to consolidate consumer debt. Because your lender can seize your property if you fail to pay on a secured debt, it’s best to avoid securing consumer debt to your assets.

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What is unsecured debt?

Unsecured debt is a type of loan or revolving credit line that is not secured to an asset you own — but is given based on your ability to repay. Some common examples include credit cards, personal loans and student loans. Because the loans are unsecured, the interest rates are typically higher. You can usually apply for these types of loans online. Lenders review your credit score, credit history and income to qualify you for an unsecured loan or credit line.

Pros and cons of unsecured debt

Unsecured loans are used for things like home improvements and consolidating consumer debt. The rates are a bit higher than secured loans, but you don’t have to pledge an asset to obtain the loan.

Unsecured debt still has risks. If you fail to repay your unsecured loan or credit card debt, you can be hit with high fees and interest rates — and your lender may send your debt to a collections agency. This can severely hurt your credit score and financial future.

How to choose between secured and unsecured debt

Borrowers don’t always have a choice between secured and unsecured debt — the type of loan often depends on what you’re borrowing for. If you need a car, for example, if you’re buying a house, you’ll need a mortgage (secured debt) rather than an unsecured loan.

But sometimes you do have options. In these situations, picking the right type of loan for your needs can impact your monthly payment, the amount of interest you pay and how much you can borrow.

For instance, you could pay for home renovations with a personal loan (unsecured) or a HELOC (secured). If you want to consolidate your credit card debt and don’t have any assets to borrow against, you’ll want to use an unsecured loan.

Questions to ask

In order to choose the right type of loan or credit line for your needs, here are a few questions you should ask.

• How much do I need to borrow? In general, secured loans have the potential to offer higher loan amounts than unsecured loans. If you need more money, a secured loan might be the better choice.
• When do I need the funds? You can get unsecured personal loan funds as quickly as the next business day. A secured HELOC might be cheaper overall, but the process is slower.
• What monthly payment can I afford? Compare monthly payments between both secured and unsecured debts to find one that works best for your financial situation. Ultimately, you need to pick a debt payment that you can afford to repay.
• Do I have home equity or another asset I can borrow against?
• What is my credit score? Secured loans usually have lower interest rates due to lenders viewing these types of loans as lower risk than unsecured loans. But if you have a high credit score, you might be able to get comparable rates on an unsecured loan.

The answers to these questions will help you determine the type of loan or credit line you’ll need. The choice often comes down to risk versus. Often, a HELOC is cheaper but riskier, while a personal loan is safer but more expensive.

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How subordinated debt affects borrowing choices

Subordinated debt plays a role in borrowing decisions, especially when choosing between secured and unsecured loans. It refers to debt that gets repaid only after higher-priority (senior) debts are settled if the borrower defaults. This concept is most relevant in cases like HELOCs, second mortgages or multiple loans tied to the same asset.

» MORE: What is subordinated debt?

Bottom line: What’s the difference between secured and unsecured debt?

Both secured and unsecured debt can be used to your advantage if you have a plan to pay it off. One isn’t better than the other, but lenders handle them differently.

The big difference is that creditors can seize your pledged asset if you fail to repay a secured debt. Think of it this way: your car will certainly get repossessed if you miss enough payments, but Sallie Mae can’t take your college degree away if you don’t pay your student loan.