If you’re going through the process of applying for title loans, registration loans, bank loans, or considering consolidating your debt, the phrases “secure” and/ord “unsecure” debt have probably come up at least once so far. You may have smiled and nodded, and pretended like you understood every piece of insane lending jargon they threw at you. But inside you were screaming, “Wait, what is that? Is that important?! Should I know this?!”
Short answer: you should know it in order to fully understand what you can expect out of your new financial situation. Here’s your chance!
So the first thing you need to know before moving on to secure and unsecured debts is how creditworthiness works. Essentially, when a loan applicant approaches a credit-provider, the credit-provider wants to know that you’ll be able to pay them back their money; it’s a matter of safety for them.
The more proof you have that you can pay off that debt (and/or that you have successfully paid off your debts in the past) then they’ll be more likely to trust you with a loan. Creditworthiness is typically measured by two indicators:
- Your credit score and financial history.
- Your list of collateral or assets.
First they’ll check your credit and financial history. If you have a history of paying all your bills on time, not owing any money to anyone, you have a steady source of income, and so on… then they’ll consider you an ideal candidate for a loan.
But if your credit score is subprime and you lack positive financial history, they’ll move on to any collateral or assets that you may own. These possessions hold value, so they can be put up against the loan as a form of collateral insurance that the creditor will get their money back.
Most forms of unsecured debt come from the first of the two types of creditworthiness indicators: credit score and financial history. The loan is based solely on your promise that you’ll pay on time. I.e. it’s not secured by any physical possessions, assets, or collateral, therefore… ‘unsecured.’
Unsecured debt is more likely to feature higher interest rates than secured debt, because the credit-provider really only has your word. That makes it a riskier loan for them to give out, so they compensate that risk with a higher rate of interest.
Since secured debt requires you to provide the credit-provider with some form of collateral, the interest rates are usually lower because the bank has a physical and more tangible guarantee that you’ll pay them back. One example of a secured loan is a mortgage. Your house is the collateral in that example.
That’s why banks require the lender to get home insurance in order to apply for a mortgage; they want you to protect their asset in case you default on the loan and they need to sell your house to recoup the money that you lost them.
Secured debts can be used with cars, property, businesses, and other types of assets and resources that the creditor approves as having good equity.