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The Unsecured Debt Guide

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Claire Matthews

Financial Advisor, DCL

Unsecured Debt

Page Contents

What are the Types of Unsecured Debt

  1. Credit card debts
  2. Personal and business loans
  3. Student loans
  4. Medical loans
  5. Unpaid house bills

In a perfect world, people won’t need to borrow money. However, the reality is that no matter how efficiently individuals try to manage their finances, there will be challenging situations. These could be unforeseen emergencies, sudden trips, or life-changing events such as moving out of your parent’s home, or quitting your job. It could be anything, really and it can happen to anyone.

Even people who are careful with their money and diligently set aside money in the bank, may be placed in a situation like this. If it happens once or twice, it’s perfectly all right. The point is being able to pay back the amount owed within the specific period in order to prevent interest and penalties. If the term of your loan or cash advance was for three years and you were able to make all your payments religiously, there won’t be any problem. You will have a good credit rating and you will be considered a good creditor by financial institutions. Problems arise when payments are missed and penalties and surcharges are added to the original sum owed.

Borrowers who are delinquent in their payments will have a hard time taking out loans or cash advances again.

Debt has always been as sure way to access quick cash, but it is important to be mindful of what you owe and when you are supposed to pay the money back.

What is Unsecured Debt?

Unsecured debt is a debt where the basis of qualification for its obtainment is your creditworthiness. Influenced by your ability to make the monthly payments in similar transactions, your credit score becomes the primary basis of the monetary value of this unsecured debt will be awarded to you. The only physical requirement demanded would be the signature on the contract, thus the moniker “signature loans.”

Just like the name implies, unsecured debts don’t require the borrower to put down property or possessions as collateral for the loan. They also don’t need to undergo credit checks or background investigation before the loan is approved. Lastly, there’s no need for another person to co-sign the loan. These sums of money are lent to people on the basis of pure goodwill.

Secured vs. Unsecured Debt

Comparing it with its polar opposite, there are three salient differences of unsecured debt to secured debt.

  1. Collateral

Collateral is a form of security for your debtors, basically a property or anything of value that they will acquire in case you fail to make your monthly debt payments. From the word, secured debt requires collateral.

Because a house or a car is the most common valuable possession one has, it is the usually put up as collateral to obtain funds.

For most personal loans, the most common form of collateral is your home or your car. These items are generally the most valuable possessions a person owns; thus they are the items put up first by consumers in an attempt to secure funding.

The disadvantage of secured loans is that should the borrower default on his payment, the bank or financial institution has the right to seize the property listed as collateral. This is a dangerous gamble, especially if it’s the family home that has been placed as collateral. Should anything happen to the borrower and the family members are unable to pay the debt, they will also end up without a roof over their heads.

  1. Monetary Amount Credited

There are numerous factors that ultimately determine the final amount. Generally, a person gets a secured debt for high amount of loans, because the creditors “match” the value of collateral. For unsecured debt, the amount they may be willing to award to you varies but will be definitely be smaller.

  1. Credit Score

While unsecured debt is considered riskier than secured debt, credit score still matters for both cases. The difference, however, is that the former would be more difficult to secure with poor credit ratings.

  1. Interest Rate

All things held equal, set interest rates are relatively more relaxed for secured debt than for unsecured debt.  Interests are higher for loans without collateral, prior credit investigation or co-signer because the banks are assuming a higher risk in lending money to the borrower.

Five Common Forms of Unsecured Debt

Credit card debts

Being the most common form of unsecured debt among all five listed here, credit card debts total at around $779 billion or an average of $16,748 per household in the U.S. alone. It is difficult to get out of credit card debt due to high interest rates, which goes even higher when you miss payments.

Personal and business loans

Some personal and business loans do not require collateral, making them a form of unsecured debt. This can be money that you borrow from friends or family or people who lend money with a small interest. In some cases, small cooperatives can also fall in this category because they don’t require collateral before lending individuals money.

Student loans

Student loans are generally unsecured as those who aspire to get a degree do not have any property they can put up as collateral. They are, however, bound by contracts that require them to pay the money they borrowed once they have graduated and become employed. Student loans can add up to a big amount of money and cause a big strain on the population. The good news is, once these loans are paid up in full, the borrower is free from debt and can start enjoying the fruits of his labors.

Medical loans

Medical debts are considered unsecured debt which a person gets especially for paying hospital bills.

Unpaid house bills

Among all five, this is the only one you do not need to apply for. Once a bill goes unpaid, it becomes essentially an unsecured debt. While there are consequences of your inability to make the payment like eviction, your creditor would not be able to seize your assets.

What are the Pros and Cons of Incurring Unsecured Debt?

Pros

No Collateral

With unsecured debt, you do not place yourself at a risk where you can lose a valuable property. You will keep all your assets intact, but failure to pay will definitely drop your credit rating. Moreover, you may never be able to secure a loan again without a sizeable collateral.

Easier Application Process

There are forms of unsecured debt which you can get without much hassle. For example, student loans are very easy to apply for despite their target market having virtually no asset. Having no collateral to add to the equation smoothens the process.

Cons

Harder to Get Approved

Without collateral to soften the risk of lending, creditors do not offer unsecured loan to everyone. In the event that it to you with bad credit rating, expect exorbitant fees and unreasonable interest rates.

Less Money at Higher Interest Rates

As already discussed, unsecured loans are riskier for the creditors. Thus, you pay for this risk through higher interest rates. They may not also be willing to loan you a high amount because it is not the best decision for them in the economic sense.

As a result, you get to pay more for less money that you owe.

Why Do Creditors Offer Unsecured Debt?

In a perfect and risk-free world, everyone would have collaterals which they can use for the loan. However, there are some people who have no valuable asset in need of money. This reality opened up a new profiting opportunity for creditors everywhere.

Despite the higher risks, unsecured debt is still more profitable for the creditors. As people are attracted to the fact that they are not risking material property in exchange for the loan, there is also a big market for it.

How Do Creditors Assess Risk when Deciding on Awarding You Unsecured Debt?

Creditors look at a wide variety of factors to determine whether to offer you unsecured loan. These five criteria are also the basis of how much money they would be willing to risk. They are the “five C’s” of credit: character, capacity, capital, collateral, and conditions. As we are discussing unsecured debt, the fourth C (collateral) becomes irrelevant.

Character

One of the factors looked into before approving or rejecting your loan, character here means your debt payments behavior in the past. They determine this by checking your credit history. Other related financial activities such as foreclosures and bankruptcies also fall under this criterion.

Capacity

To evaluate the probability of you making the payments, lenders look at your capacity to pay off the debt. Here, they will assess your income per month and its stability against the amount you want to borrow.

Capital

Capital is the money you have which you can use to secure the first payment of the loan. For example, banks are more likely to offer a credit card to a client with a high account balance compared to someone who is only maintaining the minimum amount required.

Conditions

Everything that concerns the agreement with between the lender and the debtor. This includes the reason behind taking out a loan, the interest rate, as well as the amount to be loaned.

Is There Ceiling for Unsecured Debt That You Can Incur?

Technically speaking, there is no set ceiling of unsecured loan which you can avail of. For as long as a creditor is willing to award you the loan, the ceiling goes higher.

However, if you have too much debt, you will not be eligible for some forms of bankruptcy. For Chapter 13 bankruptcy, the limit for unsecured debt as of April 1, 2016 is $394,725. Your unsecured debt is not considered a factor at all, on the other hand, when filing for Chapter 7 bankruptcy.

Of course, it is still best to consult a professional regarding your options before crossing it off the list.

What Happens to Unsecured Debt When You Die?

There are different regulations on what will happen to your unsecured debt in the event of your death depending on its type as listed above.

Credit Card Debt and Student Loans

Credit card debt, which what you know now as the most common form of unsecured debt, still needs to be settled even if you pass away. All the assets you leave behind such as your car, your house, and your stocks will be used to pay your debts. If these are valued less than the total amount you owe, there are no other ways for your creditor to seek the remainder of the payable sum.

The recourse will be different, however, if there is a joint account holder on the card or if you live in a “community property state.” In this case, your spouse or other living member of your immediate family will inherit the debt.

For student loans, there are similar but relatively more relaxed rules. Like in dealing with credit card debt, the borrower’s estate will be utilized to pay for the amount due until all assets and resources are exhausted.

After assets have been turned over, some of the biggest private lenders simply “forgive” the debt. That is only applicable, however, if do not live in a community property state.

Else, as with credit cards, your spouse or any member of immediate family will now be held responsible for repaying the rest of your loan.

What Can You Do If You Cannot Secure the Payments on Your Own?

The responsible thing to do is simply bite the bullet and continue with the payments as agreed by you and your creditor. Sometimes, certain unexpected events such as accidents or job loss may not make that possible.

Here, you have no choice but to explore other options such as debt consolidation loans. However, if at all possible, avoid unsecured debts or any kind of debt for that matter to ensure financial health and to enjoy life without creditors on your back. For more information read What is a debt consolidation loan?

FAQ

Unlike secured debt, unsecured debt doesn’t require you to put down collateral when you take out a loan. The most common types of unsecured debt include credit cards, student loans, medical bills, and back taxes. Statistics show the average unsecured debt is over $20,000. When consumers default on secured loans, banks can reclaim your home, auto, and various other personal possessions. On the contrary, unsecured debt is often sold off to a collections agency or the creditor can file a lawsuit against you if you stop making payments. The only way to get rid of unsecured debt is to pay it off completely, negotiate a settlement with the creditor, or file for bankruptcy.

Since there are a lot of doubts and misconceptions when it comes to unsecured debt, we answered some of the most common questions to help you improve your understanding.

Understanding Unsecured Debt

Credit card, utility, and medical bills are all examples of unsecured debt. Debtors should be aware of their rights when it comes to unsecured debt and what happens if they default on their payments. Just because a loan is unsecured, doesn’t mean there aren’t any financial repercussions if you default on it. It’s also important to understand your financial standing so you don’t take out too much debt. Below are the most common questions about unsecured debt that will help you better understand what it is.

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What counts as unsecured debt?
Unsecured debt is any form of debt that does not use an asset as a form of collateral. The Lender cannot legally repossess any of your personal assets if you default on the debt.
What is an example of an unsecured debt?
An example of an unsecured debt is a student loan. If you stop making payments on a student loan, the lender can’t take ownership of any of your personal assets.
Are assets in a trust protected from unsecured debt?
When you have unsecured debt, the lender cannot go after your assets. This is only a concern with secured debt. Assets in irrevocable trusts are protected from being sized by creditors.
What is unsecured debt ratio?
The unsecured debt ratio is your amount of total unsecured debt divided by your annual income. This ratio is a metric used to determine if an individual has too much unsecured debt.
Can unsecured debt take your house?
No, unsecured debt cannot take your house because there is no collateral tied to the loan. The lender can only reclaim your house if you have a secured loan.
Are medical bills secured or unsecured debt?
Medical bills are an example of unsecured debt. The party issuing the medical bill has no authority to take any of your personal assets if you fail to pay the debt.
What is unsecured credit debt?
Unsecured credit debt is when a lender offers you a line of credit that is not backed by a form of collateral. Failure to make payment will still hurt your credit but won’t affect your personal assets.
Can unsecured debt be collected?
Yes, unsecured debt can be sold to a collection agency. A credit card is a prime example of an unsecured debt where accounts go to collections if they aren’t paid off timely.
What is an example of an unsecured loan?
An example of an unsecured loan is a paycheck lender. Companies that advance paychecks don’t require collateral, instead they use proof of income as a metric to determine your eligibility.
What is unsecured lending?
Unsecured lending is when the creditor provides a debtor a loan that is not collateralized by a specific asset. The creditor can repossess the asset if the debtor defaults on the loan.
Is a car loan unsecured debt?
No, a car loan is not an unsecured debt. The lender holds the vehicle’s title and can legally repossess the vehicle when if the borrower does not make payments on the loan.
Is there debt forgiveness for unsecured credit card debt?
Yes, there is debt forgiveness for unsecured credit card debt. A creditor may be willing to settle for less than the amount of your total debt and forgive a portion of the debt.
How long does unsecured debt last?
If you make payments on the unsecured debt, it will last the full term of the loan. If you don’t make payments, it will last till the lender eventually writes it off.
What is unsecured debt collection?
Unsecured debt collection is when the original lender sells your debt to a third-party collection agency for a fraction of the price. The agency will continue to make efforts to collect until they write off the debt.
Should I consolidate unsecured debt with a home equity loan?

Yes, but only if you can secure a low interest rate and make the payments on the home equity loan. Since a home equity loan is a secured loan, the lender can foreclose your home if you don’t make payments. Some veterans use VA loans for debt consolidation.

How much unsecured debt is too much?
You can use the debt-to-income ratio to figure out how much unsecured debt is too much. Take your debt divided by your income and if you get a number higher than 40%, you have too much unsecured debt.

Types of Unsecured Debt

From credit cards to medical bills, there are many types of unsecured debt. A handful of these can be both secured and unsecured – such as credit cards. If you have a low credit score, taking out unsecure loans will be more difficult because you pose a bigger risk to the creditor. The below questions will help you understand what types of debt are unsecured.

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Is a bank loan secured or unsecured?
There are both secured and unsecured forms of bank loans. Home mortgage and car loans are typically secured whereas personal loans and students loans are unsecured and don’t use collateral.
Is a credit card secured or unsecured?
A credit card can be both secured and unsecured. While most credit cards are unsecured, there are secured credit cards where the debtor makes a refundable deposit that becomes the line of credit.
What is unsecured credit card?
An unsecured credit card requires no deposit and is not backed by any form of collateral. The majority of credit cards are secured and will not affect your personal assets if you don’t make payments.
Can debt collectors file lawsuit?
Yes, debt collectors can file a lawsuit and attempt to sue you in civil court. The debtor must file the lawsuit within the statute of limitations that each state defines.
Is a timeshare unsecured debt?
Yes, timeshares differ from homes because they are generally purchased with personal loans and not mortgages. Unlike a mortgage, the bank can’t repossess your timeshare if you default on the loan.
Is a mortgage secured or unsecured debt?
A mortgage is an example of secured debt. The lender uses your home as a collateral and retains the right to foreclose it if you default on your loan payments.
Should unsecured debt be paid off first?
No, you should pay off secured debt first because the lender can claim your assets if you don’t make the payments. Once your secured debt payments are current, you should pay off unsecured debt.
Is a student loan secured or unsecured debt?
A student loan is an unsecured debt. Like personal loans, student loans are not backed by collateral. If you default on your payments, the lender can’t claim any of your assets.
Is an overdraft unsecured debt?
Yes and no. Overdraft debt can be both secured and unsecured. Secured overdraft debt means the bank can claim your other deposits or personal property used as collateral.
Are bonds unsecured debt?
Not always. There are bonds that are both secured and unsecured. For example, mortgage-backed securities are a type of bond where the lender can claim the debtor’s home.
Is commercial paper unsecured debt?
Yes, commercial paper is a short-term unsecured debt sold by large companies. If the debtor fails to make payments on commercial paper, lenders are not entitled to the debtor’s assets.
What do lenders take into account before issuing unsecured debt?
Lenders consider your credit score, income, and personal assets before issuing unsecured debt. The biggest factor that determines your ability to get a loan is your credit score.
Are private student loans unsecured debt?
Yes and no. Most private student loans are unsecured and require no collateral. On the other hand, some students pay for school with a home equity loan that uses your house as collateral.
Can a credit card company sue you for unsecured debt?
Yes, a credit card company can sue you for unsecured debt and win a monetary judgement against you. If your debt is big enough, it’s not uncommon for a credit card company to file a lawsuit against you.
Does unsecured debt die with you?
No, unsecured debt does not die with you. The executor of the estate or any co-signers will be responsible for using your assets to pay off any outstanding debt at the time of your death.
Are payday loans unsecured debt?
Yes, payday loans are almost always unsecured debt. A payday doesn’t require any collateral to give you a loan, just proof that you have a job and a bank account.

Unsecured Debt vs. Secured Debt

Debts are either unsecured or secured. The main difference between the two is that secured loans use collateral that the lender can repossess if you default on your payments.

One of the best examples of a secured loan is a home mortgage. If you stop making payments, the bank can legally foreclose your home. Since unsecured loans don’t have the same level of backing, banks often prefer to issue secure loans. Before taking out a loan, you need to carefully analyze both the pros and cons of unsecured and secured debt.

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Which is better secured or unsecured credit card?
It depends on your credit score. If you have good credit, an unsecured card is better because you don’t have to make a deposit or use collateral. Secured credit cards are better for people with low credit because it helps them improve their credit score.
Is unsecured loan a long term debt?
Yes and no. Any loan with more than 12 months to the date of maturity is considered a “long-term debt.” If you are in the 29th year of a 30-year loan, the loan would be considered short-term debt on a balance sheet.
Is a small business loan secured or unsecured?
Small business loans are both secured and unsecured. In most cases, banks prefer secured loans because the bank can take ownership of an asset and there’s less risk.
Is IRS debt secured or unsecured?
IRS debt can be both secured and unsecured. The debt is secured only if the IRS files a lean against one of your assets. For example, the IRS could file a lien against your home and seize it if you don’t pay back taxes
Should unsecured debt be paid off first?
No, you should pay off secured debt first because the lender can claim your assets if you don’t make the payments. Once your secured debt payments are current, you should pay off unsecured debt.
Is a personal loan unsecured debt?
Yes and no. While most personal loans are unsecured, there are some that are secured. Some banks will require you to use an asset such as your car or savings as a collateral before issuing a personal loan.

How Bankruptcy and Settlement Affects Your Debt

When people find themselves drowning in debt, sometimes the last resort is to file for bankruptcy. Bankruptcy is a court order that protects a company or individual from having to pay debts back to creditors. There are two main types of bankruptcy: Chapter 7 and Chapter 13. While both are similar, there are some differences when it comes to how much debt you must pay back. Before filing for bankruptcy, consider the below questions.

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What is unsecured debt in bankruptcy?
Unsecured debt in bankruptcy is either partially or completely discharged. In Chapter 7 bankruptcy, all your unsecured debt is discharged. When you file Chapter 13 bankruptcy, you may still have to pay a portion of your debt.
How much unsecured debt can I have?
You can have as much unsecured debt that a bank is willing to lend you. In terms of bankruptcy, the maximum for Chapter 13 is $394,725 and there is no maximum for Chapter 7.
What is senior unsecured debt?
Senior unsecured debt is the debt that is prioritized when you file for bankruptcy. When a company liquidates its assets, it must first pay off the senior unsecured debt.
Can unsecured debt be written off?
Yes, unsecured debt can be written off (also known as a “charge-off”). If you don’t make payments on debt for 180 days or more, most lenders will write the debt off, depending on how much it is.
Can a creditor take my house?
Yes, a creditor can take your house if you don’t make payments by foreclosing it. A foreclosure is when the lender (typically a bank) forces the sale of the house to repay the secured loan.
What is a legal charge on a house?
A legal charge on a house establishes a lender’s rights to the home. It is a legal document held by the land registry that alerts prospective buyers about the outstanding debt not paid off on the house.
Can a debt collector collect after 10 years?
Yes, a debt collector can continue the collection process 10 years after your last payment. Each state has a statute of limitations which outlines the amount of time that has to pass before a credit cannot sue you for the unpaid debt.
Can you go to jail for not paying a personal loan?
No, you cannot go to jail for not paying a personal loan. The only way you would go to jail is if you committed fraud while taking out the loan (such as falsifying your identity).
How to negotiate unsecured debt
The best way to negotiate unsecured debt is to use a debt settlement company. These companies employ debt experts who know how to negotiate with creditors and reduce your outstanding debt.
Do you have to pay unsecured debt in chapter 13?
Yes, you must pay some unsecured debt in chapter 13 known as “priority claims.” Priority claims include child support, administrative expenses associated with filing bankruptcy, and delinquent taxes.
How to outright cancel 100 of your unsecured debt?
You can outright cancel 100% of your unsecured debt by either negotiating with the creditor to settle all the debt or filing for Chapter 7 bankruptcy to wipe out the unsecured debt.
Can I file bankruptcy on unsecured debt only?
No, you cannot file bankruptcy on unsecured debt only. You can, on the other hand, prioritize your debt and put the unsecured debt before the secured debt.
Is unsecured priority debts account for debt limit?
Yes, unsecured priority debts are part of the debt limit when you file for Chapter 13 bankruptcy. While there is no debt limit for Chapter 7 bankruptcy, you’ll still have to pay unsecured priority debts.
What is unsecured priority debt?
Unsecured priority debt is debt that you must pay first when you file for bankruptcy because it is required by public policy. This type of debt includes child support and back taxes.
Does it make sense to settle unsecured debt?
Yes, it does make sense to settle unsecured debt in some cases. If you can’t pay the debt, your only option may be to settle it with the creditor. Keep in mind that your credit score will take a big hit.
What is unsecured dischargeable debt?
Unsecured dischargeable debts that you don’t have to pay when you file bankruptcy. These include all debts not tied to a collateral such as credit card payments and medical bills.
What is a debt settlement?
Debt settlement is when a debtor attempts to negotiate a partial repayment of debt, a payment plan, or complete cancellation of debt. Many consumers pursue debt settlement with the help of a debt settlement company.
What happens when credit card debt is not paid?
The debt will likely be sold to a collections agency and the late payments will show up on your credit report. If the debt is never repaid, the company will write off the debt or file a lawsuit.
Claire Matthews

Claire Matthews

Financial Advisor, DCL

Claire is a noted financial writer and author of hundreds of articles about personal and business finance. Before getting her MBA, she graduated with a BS in Economics. Her coursework focused on the different ways that debt, debt structure, and debt restructuring affect micro and macro-economic issues.

Upon graduation, she took a job at an investment bank that worked with municipal and county governments to help them reorganize and structure their debt so they could continue to provide essential city services.

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