The Difference Between Secured and Unsecured Debt
September 10th, 2014 by A Licensed Insolvency Trustee
Not all debt is created equal. Your debts fall into one of two categories: secured or unsecured. 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.
What is secured debt?
A secured debt is one for which you have assigned collateral, which your creditor can seize if you are unable to pay. Two common examples of secured debt are home mortgages in which the home itself is the collateral, and automobile financing plans, where the vehicle is the collateral. In these situations, the creditor is said to have a “lien” on the property or vehicle. If you fail to make your mortgage payments, your lender may be able to force the sale of your home and recoup their money from the proceeds. Similarly, if you stop making your car payments your lender might choose to seize your vehicle.
Some consumers have signed a Master Credit Agreement with their financial institution as part of the process of obtaining financing. As part of this Agreement, the financial institution typically obtains a mortgage on the consumer’s home. The lender is then a secured creditor in connection with any credit extended to the consumer. This might include a mortgage, a line of credit, credit cards, and overdraft protection. If you have signed a Master Credit Agreement, all of the debts arising from that Agreement are secured debts.
Similarly, unpaid property tax may be considered to 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 amount of time (for example, two years in Ontario).
Most lines of credit and personal loans for large dollar amounts are secured.
What is unsecured debt?
An unsecured debt is a debt for which your creditor has no collateral. 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 to 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 the creditor? 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.
Powers of unsecured creditors to collect outstanding debts
In contrast to secured creditors, unsecured creditors, particularly when it comes to consumer debt, are less likely to recover their funds when a customer stops making payments. This is partially why interest on unsecured debts is higher: credit card companies must take into account that between one and three percent 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?
There are specific scenarios in which an unsecured creditor may not recover all of the monies owing to them:
- Consumer is unwilling or unable to pay their outstanding debt voluntarily
- Consumer files for personal bankruptcy or successfully makes a consumer proposal
- Consumer dies and the estate is not able to pay the outstanding account
- Consumer does not own real property and the creditor cannot take advantage of a wage garnishment to recover monies owing
- Creditor does not want to sue the consumer
- Consumer is judgment proof (has so few assets or little income that there is nothing to sue for)
- Limitation period on a consumer debt has expired
Unsecured Consumer Debt and Limitation Periods
If you have an unsecured debt, it will fall into one of two categories: consumer debt or non-consumer debt. 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 any unsecured debt except for court-awarded child support or monies owing to the government.
Provincial governments have enacted laws concerning “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. The following table sets out limitation periods for contract debt in each province and territory in Canada. Keep in mind that provincial and territorial legislation can change – we advise that you consult with a Licensed Insolvency Trustee in your area for a free consultation.
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|
|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 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.
Relevant limitation periods are specific to provinces/territories
The relevant limitation period is the one for the province in which you reside. The limitation period for contract debt is two years for the residents of Alberta, British Columbia, New Brunswick, Nova Scotia, Ontario and Saskatchewan, and three years for Quebec residents. The relevant limitation period for Canadians living outside these provinces is six years.
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 which can restart the clock on a limitation period
Two specific consumer actions can restart the clock on a limitation period. First, if a consumer makes a partial payment – before the expiry of the limitation period – then the clock on the limitation period will restart on the date of that payment. Secondly, if a consumer signs a written document acknowledging that they owe money to the creditor – before the expiry of the limitation period – then 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:
- Can a consumer avoid paying an outstanding unsecured consumer debt because of the expiry of the relevant limitation period?
- After how many years will a delinquent account be removed from a credit report?
- After how many years will collection calls stop?
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.
Regarding your credit report, 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 from your credit report. Learn more at the Government of Canada’s webpage, “How long information stays on your credit report“.
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.
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Next Steps: A Trustee Can Advise You
To learn more about insolvency solutions for unsecured debt, you can consult with a Licensed Insolvency Trustee. He or she is knowledgeable on provincial and territorial regulations, and can advise you of options that will fit your specific situation. Debt consolidation, consumer proposal, or filing for bankruptcy are alternatives you can explore. Your first, confidential appointment with a Licensed Insolvency Trustee is free.