The Differences Between Secured Debt and Unsecured Debt
Secured and unsecured debts are treated differently by banks, debt advisors and licensed insolvency trustees.
This article is meant to provide you with a basic understanding of the differences between secured and unsecured debt.
A debt is considered ‘secured’ when you have pledged one of your assets as collateral or if you took out a loan to purchase an asset and the bank has a lien on that asset until your loan is paid in full.
The most common example of a 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 needed 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 in order to get their funds repaid. A security interest reduces their risk in getting their loan repaid and that is why typically mortgages have a low interest rate.
Another common example of a secured debt would be a loan that you take out to finance the purchase of a motor vehicle. The bank or finance company would generally register a lien on the vehicle until the loan is paid in full. A lien is also sometimes referred to as an encumbrance. With a secured loan, if you don’t keep the loan payments up to date the bank can seize the vehicle. It also means that you would be unable to sell the vehicle until they are paid in full as you would be unable to transfer the ownership.
If you are having difficulty in making your payments on a secured loan or mortgage your options are limited if you wish to keep the asset held as security. Because the banks have the right to seize and sell your property it is not possible to discharge the debt in a bankruptcy or consumer proposal filing.
In other words, there is no way you can get rid of the debt AND keep your asset.
For help with this type of debt problem an appointment with a budget counsellor may be helpful. They can look at your income and expenses and determine what might be needed to help you continue making the payments on your secured debt. A lot of times, it is the cost of maintaining your unsecured debt that makes paying your mortgage and car payment difficult.
In general, unsecured debt refers to regular consumer debt not related to an asset. This could include anything from credit cards, lines of credit, consolidation loans and even old bills for services you no longer use.
When you use a credit card or line of credit to purchase an item, the store does not register a lien on the items that you are buying. If you do not pay back the money you owe on your credit cards the credit card company does not have right to seize your purchases to recover their money. It is because the debt companies have no easy way of recovering their money that they charge higher interest rates on. Credit card companies and other unsecured debts run a higher risk that they may not get back the money they loan to consumers.