The Differences Between Secured Debt and Unsecured Debt
There are two basic types of debt, secured debt and unsecured debt, and the difference is important in bankruptcy. This page explains the distinction between them, along with some other concepts of debt.
Some debt terms
- Collateral is an interest, or right, given by a debtor to a creditor, in return for something else of value, typically a loan of money. When collateral is given for a loan, it is said to secure the loan, because it reduces the risk that the creditor will lose the value of the money lent.
- A mortgage is a collateral interest given by a loan debtor to a creditor, in an asset held by the debtor, such as a house or car. The term “mortgage” is often used to refer to the agreement or to the loan itself.
- A lien or charge or encumbrance on an asset is a right held by someone, that restricts what the holder of the asset can do with it. A mortgage is a common example.
Knowing the terms above, you can easily understand the difference between secured and unsecured debts. A secured debt is a debt secured by some collateral. An unsecured debt is one where no such security is agreed.
The biggest secured debt in most people’s lives is the mortgage loan which finances the purchase of a house. The loan is secured by a mortgage on the house itself.
The next biggest secured debt for most people is the mortgage loan which finances the purchase of their car.
If you fall behind on the agreed payments on your loan, the creditor has the right to seize the security for the debt (the house or car) and sell it to recover his money. This is called foreclosing. If the creditor gets more from the sale than the debtor still owes, he must give the excess to the debtor. If the creditor gets less from the sale, the debtor will still owe the difference.
Many people assume that if they go bankrupt, the credit card company can take back whatever they purchased with a bank or store credit card. But this is not true.
What you owe on a credit card is an example of unsecured debt. In other words, liens are not typically registered on items that you buy with your credit card.
Naturally, if you buy a new sofa on your credit card the day before you file for bankruptcy, the credit card company will assume you have committed fraud, and they will demand payment in full for your purchase. However, that still does not make it a secured debt, because no lien was registered against your sofa.
Most of your bills are for unsecured debts. Some other examples are taxes, utility bills, and medical bills. All of these can be discharged by a bankruptcy.
Because unsecured debt carries more risk for the creditor, he charges a higher interest rate than for secured debt. So you can save more money in interest expense by paying off the unsecured debt first.
How does this affect your debt problems?
Read more about the effect of bankruptcy on your debts.
Since secured and unsecured debts are treated so differently in a bankruptcy or consumer proposal, it is vital to be sure which is which. Whether a debt is a secured debt or unsecured debt can be confirmed by a trustee, so if you are confused we suggest you consult a trustee for further information.