To understand your debt better you need to be able to differentiate between the two types of debt. So which is more important you ask?
There are two major types when it comes to debt: secured debt and unsecured debt. When borrowing money knowing the difference is important, for prioritizing your debts during payoff, and for insuring you keep your assets.
Secured debts are exactly that, they are debt that is tied to an asset that’s considered collateral for the debt. Creditors place a lien on the asset (for example: car, motorbike, boat), giving them the right to take the asset if you fall behind on your payments or choose not to pay the debt back.
If the lender has to take your asset because you’ve defaulted on the arrangement, the asset will then be sold to recover costs. Be warned though, that if the selling price for the asset doesn’t completely cover the outstanding debt amount, the lender may pursue you via legal means to recover the difference.
Bond and vehicle loans are examples of secured debt. Your bond is secured by your home; similarly, your vehicle loan is secured by your automobile. If you default on these loan repayments, the credit provider can proceed via legal means to foreclose or repossess the property. A title loan is also a type of secured debt because you’re using your vehicle as collateral for the debt.
There is always the misconception that the house or car you’re paying off belongs to you. Be advised you never fully own the asset tied to secured debt until the loan has been settled in full.
Hence the ability for banks to take repossession action against you if your house and vehicle are not insured, because it means “their” asset is not insured should you do damage to it. If you were not aware of this fact now is the time to pull out your assets contracts and read the fine print under a microscope.
When the debt is completely paid in full, then can you ask the lender to release the asset and give you a title that’s free of any liens. Then and only then, does the asset belong to you completely.
With unsecured debts, the credit provider doesn’t have any rights to any collateral for the debt. If you fall behind on your debt repayments, they generally cannot take any of your assets for the debt.
“NOW” don’t get confused! It doesn’t mean they cannot pursue legal action against you to the point of obtaining a Warrant of Execution; thereby attaching your assets to obtain their money.
They normally start this process by getting debt collection agents involved to coax you into paying.
They’ll also report the bad payment status of your account to the credit bureaus so it can be reflected on your credit report. Don’t be fooled, lenders of secured debts take these actions, too.
So plainly speaking, secured debt means there’s an asset already involved, unsecured means higher risk as there isn’t an asset already involved and therefore more work trying to obtain the money back if the debtor doesn’t pay up.
Secured and Unsecured Debts how to Prioritize
So as we’ve explained if the debt is tied to a specific piece of property, then it’s a secured debt. So if you’re hard up for cash and faced with the difficult decision of paying only some of your accounts, the secured debts are typically the best choice. The reason we state this is because these payments are often harder to catch up with, not to mention the interest involved, and you stand the chance to lose essential assets – like your home – if you fall behind on payments.
The only time you might give more priority to unsecured debts, is if you’re making extra payments to pay off some debt. Unsecured debts most of the time have higher interest rates which makes it expensive to spend a long time paying these off. Therefore never pay less than the minimum installment, and when you can pay more into the debt to settle it faster.