What is the difference between a Secured and Unsecured debt?
By Administrator 07 June, 2013
A secured loan is one that is backed by some sort of collateral or asset. This basically means that the lender will “hold” the collateral (ie the asset) until you pay off the loan. Whilst the asset is held as collateral or security for the loan, you cannot deal with the asset in any way without the lender’s approval. If for any reason you default on the loan, the lender has the right to take possession of the asset and sell it to repay the debt. This is also known as “foreclosure” or a “mortgagee sale”. If there is a shortfall after the sale of the asset (ie the asset sold for less than what was owed then the lender can claim the shortfall but this amount will become an unsecured debt).
Typically secured loans attract a lower rate of interest. That is because the risk involved for the lender is a little less (ie the lender has recourse against an asset in the event that you don’t pay the loan repayments). The lender will not usually lend 100% of the value of the asset. For example if you want to buy a house most lenders in the current market will only lend up to say 90% or 95% of the value of the house. That is because the lender is reducing its risks of incurring a loss in the event of foreclosure.
An unsecured loan is where no security or collateral is provided for the loan. The lender is taking the full risk that you will repay the loan on the terms agreed. If you fail to make the repayments, the lender doesn’t have any asset to sell to recover its debt. In the event of non-payment the lender may commence formal debt recovery proceedings which may lead to bankruptcy. As a result of the high risks involved, lenders will charge higher rates of interest. For example, a credit card is unsecured and typically attracts a high rate of interest.
What should you do if you can’t afford to repay these debts?
Can’t repay a secured debt – what should I do?
If you can’t afford to repay a secured debt, then you will need to speak to the lender and make arrangements to surrender the asset and allow the lender to sell it or you can seek the lender’s permission and sell the asset yourself. Of course if you sell the asset yourself you will need to remit the proceeds to the lender in repayment of the debt. Remember because the asset is “charged” you cannot sell the asset without the lender’s express permission. If there is a shortfall on the sale of the asset the debt will become unsecured. If you can’t pay the shortfall read below as to what may be your options.
Can’t repay your unsecured debts – what should I do?
If you can’t pay your unsecured debts you should start by seeing if you can reach an informal arrangement with your creditors. If the informal arrangement isn’t successful or your creditors as a group won’t agree you may then wish to consider a formal arrangement. To understand the difference between a formal and informal arrangements with your creditors click here.
Call us now at 1800 676 598, if you need any help understanding the differences between secured and unsecured debts. Our personal debt advisors are here to help you now.