Unsecured debt isn’t backed by a debtor’s collateral but typically carries interest rates that are higher than debt backed by assets.
What Is Unsecured Debt?
Unsecured debt is debt that is not backed by any asset or collateral. Borrowers of unsecured debt don’t have to worry about seizure of an asset due to nonpayment, but there are consequences for delinquency or default.
Due to the lack of collateral, unsecured debt has a relatively high default risk. This type of debt typically carries higher interest rates to compensate lenders for the risk they’re taking on.
What Are Some Common Types of Unsecured Debt?
There are many types of unsecured debt available for consumers in the U.S., where approval for loans tends to be easier to secure than in other countries and is typically based on a debtor’s creditworthiness. Common types of unsecured debt include:
Credit card debtPersonal loansStudent loansMedical debtOverdraft loansBuy now, pay later (BNPL)
When it comes to unsecured debt, interest tends to compound monthly, and there are a variety of factors that can lead to a change in rates, including changes in a person’s income, missing a payment, and the percentage of debt taken compared to the available limit.
Secured vs. Unsecured Debt: What’s the Difference?
While unsecured debt isn’t backed by collateral, secured debt is backed by an asset, such as a house for a mortgage or a car for an auto loan. Unsecured debt tends to carry higher interest rates than secured debt to account for the lack of collateral.
What Happens to Unsecured Debt in a Bankruptcy?
In a bankruptcy, such as a Chapter 7 filing, debtors are able to discharge their unsecured debts. Most of the time, unsecured debt is wiped out. If it is not, repayment plans tend to require only a fraction of the total amount owed. However, there are consequences for those going bankrupt. It can be very difficult to get new loans, such as credit cards, and a bankruptcy filing can remain on an individual’s credit report for up to 10 years.
What if a Payment Is Missed on Unsecured Debt?
A creditor may charge fees and raise interest rates for missed payments. A creditor may also report missed payments to credit bureaus, which could lead to a reduction on the debtor’s credit score, such as their FICO score.
What if You Default on Unsecured Debt?
For defaulting on an unsecured debt, a creditor may turn to a collection agency, which is a third-party group tasked with collecting payment. A person from a collection agency may turn up at a debtor’s house unannounced. A creditor can also take legal action by going to court to seek payment.