What is Unsecured Debt? Definition and Examples
Unsecured debt does not come with a collateral requirement. This type of debt is fairly common and includes personal loans, student loans and credit cards. If you want to access a form of financing without the risk of losing an asset, an unsecured loan could be a great choice. Here’s what you need to know about these loans before applying with a lender.
What is unsecured debt?
The term “unsecured debt” refers to financing that is not backed by collateral, which is an asset that you own, such as your home or a vehicle. Personal loans, credit cards and student loans are all examples of common types of debt that are unsecured.
Since there is no asset that the lender can seize if you default, unsecured debt is often thought of as less risky for the borrower than secured debt. As a result, unsecured debts are often more difficult to qualify for compared with loans that involve collateral. They also typically come with higher interest rates.
Unsecured debt vs. secured debt
In contrast to unsecured debt, secured debts are attached to an asset that is used as collateral. If you stop making payments on a secured loan, the lender has the right to repossess your asset as a form of repayment. Car loans, mortgages, home equity loans and home equity lines of credit (HELOCs) are all common types of secured debts.
In exchange for the lender’s right to repossess your asset if you default on your loan, secured loans usually come with more lenient eligibility requirements and more affordable interest rates than unsecured debts. For example, according to the Federal Reserve, the average APR on a new 60-month auto loan in August 2023 was 7.88%. Meanwhile, a 24-month personal loan during the same time period had an average 12.17% APR.
FYI: What happens if you don’t pay back your debts?
If you can’t keep up with your payments, there will be a negative impact on your credit score, regardless of whether the debt is secured or unsecured. Payment history accounts for around 35% of your FICO score. As a result, missed payments are typically reported to the three credit bureaus — TransUnion, Experian and Equifax — and can cause your score to drop by a few points.However, secured debt comes with an additional consideration. If you default on the loan, the lender can repossess the assets being used as collateral.
Here’s a closer look at how the two types of debt compare:
| Unsecured debt | Secured debt | |
|---|---|---|
| Asset attached | No | Yes |
| Borrower holds title for the asset before repayment | N/A | No |
| Borrower holds title for the asset after repayment | N/A | Yes |
| Typical interest rate | Usually higher | Usually lower |
| Consequences if borrower defaults on loan | Decreased credit score | Decreased credit score and repossession of asset used as collateral |
| Examples |
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Common eligibility requirements for unsecured debt
Now that you know more about unsecured debt and how it functions, it may help to understand some of the typical eligibility requirements you’ll face with unsecured debts, including:
- Credit score: Since unsecured debts are riskier for the lender, credit history typically plays a large role in loan approval because it shows how likely you are to pay back the loan as promised. In many cases, you’ll need a good-to-excellent credit score to qualify for an unsecured loan. For others, bad credit loans may be available. However, these loans often come with higher interest rates, which can increase your total cost of borrowing.
- Income: In addition to checking your credit score, your lender will likely want to verify your income before approving you for an unsecured loan. The verification process helps them ensure that you make enough money to comfortably keep up with your monthly payments.
- Debt-to-income ratio (DTI): Your debt-to-income ratio is a measure of your total monthly income versus the sum of your monthly, recurring debts. It tells the lender how effectively you’ll be able to manage taking on a new loan payment.
How to get rid of unsecured debt
With unsecured debt, you have two options to get rid of your obligation: pay off your debt or file for bankruptcy. Here’s what to know about each method:
Pay off debt
Here are four options to help you pay back your debts:
- Rethink your budget: Budgeting to pay off debt involves leveraging your existing income and debt payoff strategies like the debt snowball method and debt avalanche method to slowly chip away at your unpaid balances over time.
- Consider a debt consolidation loan: If you’re having trouble keeping track of multiple balances and due dates, you may want to think about taking out a debt consolidation loan. As the name suggests, this type of loan allows you to streamline multiple debts into one more manageable monthly payment.
- Enroll in credit counseling: For those who think they may need a helping hand tackling their debt, there is credit counseling. Certified credit counselors can teach you financial literacy skills and help you negotiate a debt management plan with your creditors. The National Foundation for Credit Counseling (NFCC) provides a list of reputable providers that you can contact for assistance.
- Get help from a debt relief company: Debt relief, also known as debt settlement, involves hiring a company to negotiate with your creditors to accept a portion of the balances that you owe. These companies can help you negotiate lower payments or more affordable interest rates. However, there are some less-than-reputable companies out there and most charge fees for their services, so be sure to research providers carefully if you’re thinking of going this route.
- Pursue debt forgiveness: As you might be able to guess, debt forgiveness involves asking a lender to forgive all or part of your debts. The types of forgiveness programs available to you will depend on the type of debt that you are trying to erase. However, many lenders offer hardship arrangements that may be worth investigating if your debt is beginning to feel unmanageable.
File for bankruptcy
If your debts are truly insurmountable, you can also consider filing for bankruptcy. Bankruptcy is a method for getting most of your debt discharged, but it should only be considered as a last resort.
It severely damages your credit score and stays on your credit report for up to 10 years, which can make it very difficult to be approved to take on new debts in the future.
There are two types of bankruptcy for you to consider, based on the particulars of your financial situation:
- Chapter 7: Chapter 7 bankruptcy is sometimes called “liquidation bankruptcy” because some creditors may require you to liquidate your assets to resolve your debts. However, once the process is over, most of your debts will be forgiven. Notably, some debts, including tax liens and child support, are not eligible for forgiveness. This type of bankruptcy stays on your credit report for 10 years.
- Chapter 13: Meanwhile, Chapter 13 bankruptcy allows you to keep your assets, but requires you to follow a structured payment plan for a number of years before the remainder of your debt is forgiven. This type of bankruptcy stays on your credit report for a total of seven years.
There is also Chapter 11 bankruptcy, but that is for businesses that are unable to keep up with their debt obligations.
Frequently asked questions
Any type of loan that doesn’t come with a collateral requirement is considered an unsecured debt. Personal loans, credit cards and student loans are common examples.
Yes, you have to pay off unsecured debt according to the terms outlined in your loan agreement. If you miss payments, it can have a negative impact on your credit score and eventually the debt may end up in collections.
If a debt is unsecured, the loan agreement will likely specify that there is no collateral requirement. On the other hand, if there are loan terms outlining how an asset will be used as collateral, the debt is probably secured.