When it comes to debt, it is important to understand the difference between secured debt and unsecured debt. There are many financial myths surrounding different areas of money and it is important to recognize that not all debt is the same — and not all debt has to be repaid the same way.
Secured Debt
When you get a secured loan, you are borrowing money using an asset as collateral. In the case of a mortgage loan, you are securing the debt with your house. Your car loan is even a secured loan, since the lender can repossess your car if you don’t make payments. The point of secured debt is that it offers a measure of protection to the lender. They are giving you money, and if you don’t repay the loan, they lose that money. A secured debt, though, provides recourse; the lender can seize the asset associated with the debt.
Even credit cards can be secured. A secured card is one that you might have to have attached to a savings account. You have to keep a certain amount of money in the account so that the credit card issuer can seize it in the event that you stop making payments.
Unsecured Debt
On the other hand, unsecured debt is a completely different story. You aren’t providing an asset as collateral to the lender. The most famous examples of unsecured debt are credit cards. In most cases (unless you are purposely getting a secured credit card for the purpose of rebuilding your credit), what you charge on a credit card is unsecured. This means that if you don’t pay what you owe, a creditor can’t seize your assets — although the creditor can sue you through the court system for payment. One of the reasons that it is such a serious thing to consolidate your debt using a home equity loan is because you often take unsecured credit cards and then secure them with your home.
Making Payments: Secured vs. Unsecured Debt
While it’s best if you can manage your money so that you meet all of your obligations, the truth is that, sometimes, you have to make a choice between which bills to pay. If you are in that situation, you need to prioritize your debt. It’s important to note that you should pay on your secured debts first. If you skip a couple credit card payments, your credit score will be affected, but creditors will have a hard time taking your assets. If you miss a couple mortgage payment, though, you could find yourself without a house. Make sure you take care of secured debt payments first in order to protect your assets.
Thanks for the explanation. I always get the two confused. Funny since I have a bit of both. Do you think it would make sense if everyone had a secured credit cards? Seems like we would all do a better job managing our money.