Unsecured debt doesn't require collateral, such as a vehicle or a home, to get approved for it.
Because unsecured debt doesn't have assets attached to it, lenders take on more risk. That means interest rates are typically higher and approval is based on credit.
Personal loans, credit cards and student loans are some common types of unsecured debt.
To get rid of unsecured debt, you'll have to pay it off or seek a legal recourse to get it discharged.
Unsecured debt is any debt that isn’t backed by collateral. Since there isn’t an asset that can be seized if you default, it’s riskier for the lender. To compensate for this risk, lenders usually charge higher interest rates than those of secured debt.
Taking on this form of debt is common. As long as you know how to manage your debt properly, you can use unsecured debt to work toward your financial goals.
Unsecured debt vs. secured debt
Unlike unsecured debt, which doesn’t require you to put up any assets as collateral, secured debt requires an asset be attached to it.
Since secured loans have assets attached to them, lenders typically charge lower interest rates, as they represent a lower risk. For example, while they’re similar products in terms of loan amounts and repayment terms, home equity loans — a type of second mortgage — have an average rate of around 9 percent. Personal loans, on the other hand, which are usually unsecured, have an average rate of just above 11.5 percent.
However, both secured and unsecured debt affect your credit. If you miss a payment, this may be reported to the three major credit bureaus: TransUnion, Experian and Equifax. This, in turn, can cause your credit score to drop by several points. Negative marks from missed payments can also stay on your credit report for up to seven years.
Consequences of defaulting
Lower credit score
Lower credit score and repossession of asset
Given a title after repaying loan
Unsecured debt examples
Credit cards and most personal loans are among the most common types of unsecured debt. Although lenders typically charge higher interest rates on these types of debt, there are ways to get around this.
For instance, you may be able to qualify for an introductory rate of 0 percent on a credit card. You might also bypass the higher interest rates if you pay your credit card bill in full each month, though it depends on what type of credit card you have.
When it comes to personal loans, you usually can secure rates of under 7 percent if you have excellent credit and high, steady income. However, with these loans, there aren’t any workarounds to avoid paying interest.
Are student loans secured or unsecured?
Although federal student loans are backed by the government, you aren’t required collateral to get approved for these loans. Same goes for private student loans. Because of this, both of these fall into the unsecured debt category.
Secured debt examples
In the case of auto loans, your loan is backed by your vehicle, so defaulting on it means the lender can seize this asset. When it comes to mortgages, home equity loans and home equity lines of credit, defaulting puts you at risk of foreclosure.
While lenders tend to offer lower interest rates for these kinds of loans, there’s no way to avoid paying interest.
What happens if you don’t pay an unsecured debt?
Although a lender can’t initially take your assets for not paying an unsecured debt, you’ll face other consequences. For one, you’ll be charged late fees for paying late. And if you go too long without making a payment, your unsecured debt will be sent to a collection agency.
Once your debt is sent to the collection agency, your credit score will decrease since payment history accounts for 35 percent of your score. This will make it harder for you to obtain loans successfully in the future.
Depending on what type of unsecured loan you have, your wages might be subject to garnishment if you fail to repay your debt. A creditor might also sue you in court and place a lien against your property. If a court awards a judgment to the lender, this could put your assets at risk. Laws vary by state regarding which personal assets are exempt from seizure.
How to get rid of unsecured debt
In dealing with unsecured debt, there are two primary options: pay off the debt or file for bankruptcy.
Pay off the debt
To pay off the debt, there are several potential paths you can take.
Rework your budget. If it is possible for you to reduce your expenses elsewhere, you can shift your finances to pay down the debt faster by dedicating more of your expendable or unassigned income toward eliminating the debt.
Consolidate. You can also seek a debt consolidation loan to replace old debt with new debt, typically at a lower interest rate. However, these loans are not always beneficial to you and may have an adverse effect on your credit because they will close multiple accounts while creating new debt.
Hire a debt relief company. Another way to tackle unsecured debt is by working with a debt relief company. These companies work with your creditors to settle your balances from less than what you owe in exchange for a fee. However, they typically require you to be behind on payments to be eligible for their services, plus have upwards of $7,000 worth of unsecured debt.
File for bankruptcy
If paying back the debt is not an option for you due to financial troubles, you may need to consider filing for bankruptcy. There are multiple options for bankruptcy, including Chapter 7 and Chapter 13, which you will have to choose based on your financial situation.
If you file for Chapter 7 bankruptcy, your unsecured debt will largely be wiped out in several months. If you file for Chapter 13 bankruptcy, you will agree to pay a portion of your outstanding debt over a three- to five-year period, at which point the remaining debt will be discharged. It’s also worth noting that if you do file for bankruptcy, there’s always a chance that federal student loans won’t be discharged.
That said, bankruptcy should only be pursued as a last resort when debt is truly unmanageable. Bankruptcy stays on your credit report for up to 10 years, and your credit score will take a significant hit. This combination can affect your future access to affordable rates or even credit approval.
With unsecured loans, your assets are not at risk of being seized unless the court awards a judgment to the lender. However, it is still important to understand the consequences of not paying your unsecured debt. To avoid late fees and serious harm to your credit score, create a plan to pay off your unsecured debt before applying.