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The Differences Between Secured Debt and Unsecured Debt

Secured and unsecured debts are treated differently by banks, debt advisors and Licensed Insolvency Trustees. Whether you are struggling to keep up with your bills or considering personal bankruptcy or consumer proposal, the distinction between secured debt and unsecured debt can be critical.

This article will give you a basic understanding of the differences between secured and unsecured debt.

secured debt vs unsecured debt

What is secured debt?

A debt is considered “secured” when you have pledged one of your assets as collateral or if you have taken out a loan to purchase an asset and the bank has a lien on that asset until your loan is paid in full.

Secured debt examples

A common secured debt is a mortgage. When you borrow money to buy a house, the bank is said to have a collateral or security interest in the property. This means that you give the bank an interest in the property in exchange for the money you need to buy the property. You are not allowed to sell the property without the bank getting paid from the proceeds. If you fall behind on your payments, the bank also has the right to seize and sell your property to recover its funds. The bank’s security interest reduces its risk; that is why mortgages typically have lower interest rates than unsecured debts.

Legal speak: A lien is also sometimes referred to as an encumbrance.

Another common secured debt is a motor vehicle loan. The bank or finance company typically registers a lien on the vehicle until the loan is paid in full. With a secured loan, if you don’t keep the loan payments up to date the bank can seize the vehicle. 

You are legally barred from selling homes/land or vehicles that have been used for security until your secured creditor is paid in full. If the creditor has not been paid, you will be unable to transfer the ownership.

It is interesting to note that it is often the cost of maintaining the asset you have posted as security (home or car) that makes paying your mortgage and car payment difficult.

Unpaid property tax may also be a secured debt because, under most provincial legislation, a lien can be registered against a property on which municipal taxes are in arrears for a certain length of time (for example, two years in Ontario).

Most lines of credit and personal loans for large dollar amounts are also secured.

Secured debts and bankruptcy or consumer proposal

Because the banks have the right to seize and sell property used as security, it is not possible to discharge secured debts in a bankruptcy or consumer proposal

Despite this, secured debts are still affected by the filing of a bankruptcy or consumer proposal. 

In a bankruptcy, it is typical for the Trustee to be required to seize and sell secured assets because the consumer owns a large part of their value (equity). The equity that the consumer owns is considered an asset, and part or all of it may be needed for the satisfaction of unsecured creditors. In a consumer proposal, liquidation of secured assets is often not needed. A Licensed Insolvency Trustee can provide further details specifically for your situation.

What is unsecured debt?

An unsecured debt is a debt for which your creditor has no collateral. In general, unsecured debt refers to regular consumer debt not related to an asset.

When you use a credit card or line of credit to purchase an item, the store does not register a lien on the items you are buying. Credit card companies and other unsecured debt sources run a higher risk than secured creditors that they may not get back the money they loan to consumers; this is why they charge higher interest rates.

Unsecured debt examples

In Canada today, most credit cards are unsecured debt. Some, but not all, lines of credit and personal loans – particularly for smaller amounts – are unsecured debt. Any monies you owe to the government for income taxes or student loans are also unsecured debt. Finally, amounts owing to phone companies, internet service providers and cable television companies are unsecured debt.

Secured Creditors vs. Unsecured Creditors: How Do They Collect Monies Owing?

Powers of secured creditors to collect outstanding debts

If you are late with payments to a secured creditor, that company will send notices and make phone calls to you for a few months, trying to encourage you to get up to date with your payments. They will not wish to take further action until they are sure you will not otherwise pay them. Recovering debts via seizing collateral involves significant expenses for creditors.

That being said, secured creditors can usually recover the monies owed to them when a consumer fails to make their payments.

Secured creditors can look to their collateral to recover monies from a consumer in default. The key concern for secured creditors is the size of their security: is it large enough to satisfy the amount of money the debtor owes? A financial institution holding the first mortgage on a house should be able to recover one hundred percent of monies owing on a mortgage loan, provided the house’s market value is greater than the amount owed by the consumer.

Secured creditors can initiate a legal process to recover monies owed via seizing the assets used as collateral. Provincial legislation includes various creditors’ rights and restrictions – a Licensed Insolvency Trustee can advise you of how property seizures are undertaken in your province.

Powers of unsecured creditors to collect outstanding debts

In contrast to secured creditors, unsecured creditors are less likely to recover their funds when a customer stops making payments. This is one of the reasons that interest on unsecured debts is higher: credit card companies must take into account that some of their customers will default on what they owe, and the company may have no recourse.

Like secured creditors, unsecured creditors will try to contact you before taking next steps to recover their funds. After many months, when it appears that you cannot or won’t pay, most unsecured creditors pass your account along to a collection agency. The collection agency takes on the job of trying to contact you, and their letters and calls can be quite upsetting, even when their actions stay within the bounds of Canadian legislation. See our page, What Can A Collection Agency Do to Me in Canada?

If you own “real property” (large assets such as real estate or vehicles) an unsecured creditor may be able to sue you to obtain a court order allowing them to recover the monies owing by seizing your property or claiming some of its value when it is sold. Thus, they can access the value of this property, just as a secured creditor could.

An unsecured creditor may also gain access to your wages to pay off your debt to them – again via suing you and obtaining a court order. See What Are My Options If My Wages Are Garnished?
In specific scenarios, an unsecured creditor may not recover all of the monies owing to them:

  1. Consumer is unwilling or unable to pay their outstanding debt voluntarily
  2. Consumer files for personal bankruptcy or successfully makes a consumer proposal
  3. Consumer dies and the estate is not able to pay the outstanding account
  4. Consumer does not own real property and the creditor cannot take advantage of a wage garnishment to recover monies owing
  5. Creditor does not want to sue the consumer
  6. Consumer is judgment proof (has so few assets or little income that there is nothing to sue for)
  7. Limitation period on a consumer debt has expired

Unsecured Consumer Debt and Limitation Periods

Secured Loan

Unsecured debts fall into two categories: non-consumer debt and consumer debt. 

Unsecured non-consumer debt includes any monies owing to the government as well as obligations arising from court-ordered child support or spousal support. 

Unsecured consumer debt includes almost all other unsecured debt.

Provincial governments have enacted laws defining limitation periods, which strongly discourage unsecured consumer creditors from suing debtors after a certain time has passed. Any creditor who considers suing a consumer after the expiry of the relevant limitation period – the one for the province where the consumer lives – is at a major disadvantage.

Summary of Canadian limitation periods by jurisdiction, for contract debt*

Province or Territory Length of Limitation Period in years Significance of expiry of limitation period
B.C. 2 Gives rise to affirmative defence
Alberta 2 Gives rise to affirmative defence
Saskatchewan 2 Gives rise to affirmative defence
Manitoba 6 Gives rise to affirmative defence
Ontario 2 Gives rise to affirmative defence
Quebec 3 Gives rise to affirmative defence
New Brunswick 2 Gives rise to affirmative defence
Nova Scotia 6 Gives rise to affirmative defence
Newfoundland 6 Debt extinguished
PEI 6 Gives rise to affirmative defence
NWT 6 Gives rise to affirmative defence
Nunavut 6 Gives rise to affirmative defence
Yukon 6 Gives rise to affirmative defence

*Limitation periods within Canada range between two and six years, and have different legal implications. For a summary of legal aspects of debt collection, see our page Canadian Debt Collection Laws. And, because provincial and territorial legislation can change, we advise that you consult with a Licensed Insolvency Trustee in your area for a free consultation.

Limitation periods only apply to unsecured consumer debt

Limitation periods do not apply to secured debts. Nor can you can take advantage of the expiry of a limitation period on non-consumer unsecured debt. This means that limitation periods do not apply to court-ordered child support or spousal support, or monies owed to the government such as income tax arrears (although income tax arrears are often cleared by bankruptcy or consumer proposal).

The clock on the limitation period starts to run on the last day you paid

It is very helpful to think of a limitation period as a clock. The clock on the limitation period on your unsecured consumer debt begins to run when you default on your obligation. This almost always means that the clock on your limitation period starts to run on the date of your last payment or possibly 30 days thereafter.

Actions by a consumer that can restart the clock on a limitation period

Two specific consumer actions can restart the clock on a limitation period.

  1. Making a partial payment. If a consumer makes a partial payment before the expiry of the limitation period, the clock on the limitation period will restart on the date of that payment.
  2. Signing a document acknowledging the debt. If a consumer signs a written document acknowledging that they owe money to the creditor – before the expiry of the limitation period – the clock on the limitation period will restart on the date of the written acknowledgement.

Consequences of the expiry of a limitation period

In practical terms, most creditors will not sue regarding an unsecured consumer debt after the expiry of a limitation period, because their chance of success in court is small.

Consult a local Licensed Insolvency Trustee regarding specific legislation in your province.

How Does the Passage of Time Affect an Unpaid Unsecured Consumer Debt?

Three distinct questions arise in connection with the passage of time and unpaid consumer debt.

1. Can a consumer avoid paying an outstanding unsecured consumer debt because of the expiry of the relevant limitation period?

Possibly. Once your unsecured consumer debt is six months in default, most creditors will hire a collection agency to collect your account on a commission basis. You will likely be contacted frequently by the collection agency for months or years if the debt remains unpaid. Your creditor or the debt collection agency may initiate a lawsuit during this time. However, years later when the limitation period on your unsecured consumer debt expires, it will become very difficult for your creditor to collect, and the odds are remote that you will be sued. The court will note the expiry of the limitation period, and is much more likely to side with the debtor.

2. After how many years will a delinquent account be removed from a credit report?

Six years. If you stop making payments on an unsecured consumer account, your creditor will typically report this to a credit bureau (TransUnion or Equifax, or both), and this will appear on your credit report. A poor credit score can affect whether or not you can obtain credit – and if so, how expensive it will be for you to borrow money. An unpaid account will appear on your credit report for six years from the date of your last payment, after which it is automatically removed. Learn more at the Government of Canada’s webpage, “How long information stays on your credit report“.

3. Will the expiry of a limitation period cause calls from a collection agency to stop?

Not necessarily. Expired limitation periods do not always discourage collection agencies from calling consumers to demand payment of unpaid accounts. In some provinces, creditors and collection agencies routinely demand payments from consumers after the expiry of a limitation period. A Licensed Insolvency Trustee can tell you about the regulations in your province.

Next Steps: A Trustee Can Advise You

Difficulty in paying your unsecured debts is a sign that you may need the services of a Licensed Insolvency Trustee. Your obligation to pay these types of debts in full can be eliminated by filing a consumer proposal or an assignment in bankruptcy.

When you meet for your free, confidential, no-obligation first consultation, your Trustee will review your financial situation, explain what options you have and which one would be the best course of action for you. The goal is for you to have a fresh start and a better financial future. Tens of thousands of Canadians do so every year.

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