I hear the terms secured and unsecured debt all the time and often wonder what’s the real difference.
Is one better than the other, and if so, which one do I need to have? I also wondered, which is best for my credit score?
Whenever I get this curious bug, I have to do the research, and from there I have to put a plan in action. I have to plan to make sure that I am doing everything possible to keep my credit score growing.
I’m trying to get to the 800’s, people. That’s just my personal goal, I have to keep reaching for the top, right? Any who……..Let me share what I’ve learned!
Secured debt is borrowing with collateral. You have to have something of value the lender can take away, in case you default on the loan.
Most loans nowadays are secured loans. For example, your mortgage is a secured loan.
Now, you might be thinking, I had nothing of value when I purchased my home, they saw my credit score and credit history and that’s what helped me get the loan.
While this is true, you also had collateral. The moment they approved you for the loan, you had thousands of dollars worth of collateral.
If you default on your mortgage, the lender can take your home. Collateral!
But, why are these loans so common? Well, thanks to counterparty risk secured loans are popular and lenders have no qualms about using them.
What is counterparty risk? This is a term that means “the risk of default on the loan debt. In other words, because you have more to lose than they do if you default, the likelihood of you defaulting is little to none.
Think about it, most people that purchase a home will try everything in their power to keep their home. Everyone needs shelter, so paying your mortgage, like paying rent, is the utmost priority in your life.
If not, you could lose your home, you need a home. The mortgage company doesn’t!
Because the collateral is of high value to the consumer, lenders can offer these loans at a lower interest rate.
Another thing to keep in mind, when it comes to secured debt, is it has to be insured by the borrower.
This gives the lender some type of guarantee the item will be maintained and keep its value.
So what are some other examples of secured debt?
Examples of Secured Debt
Federal Student Loans
Secured Credit Card
Small Business Loan
Car, Home, Business
Unsecured debt is given without collateral. This means greater risk to the lender and therefore greater risk and high interest rate for you.
These are the loans that you have that were given to you because of your credit score or credit history.
These are also the loans that can quickly be turned over to collections if you default on them.
Most credit cards are unsecured debt, because you don’t have to put up collateral to get them. They are solely based on your credit history and the interest rates are usually high.
These are the debts that are usually sent to collections or can get you sued if you default on them. They could even come after your retirement!
Another thing to keep in mind, some secured debt can become unsecured debt.
Examples of Unsecured Debt
Unsecured Business loans
Cell Phone Bills
Rent and lease payments
Which is better to have?
This is a really hard question to gauge because most of the credit we get, at least when we're starting out, is secured debt.
Therefore, there is nothing wrong with having secured debt. However, like with any debt, we never want to go overboard and develop bad habits when it comes to debt.
In the case of secured debt, remember, you have more to lose than they do because you have put up the collateral for the loan.
Unsecured debt does prove that you are a responsible consumer, because it is given to you solely based on your credit score and history.
Which is better for my credit score?
Think about this, 10% of your credit score factor is types of credit. So, honestly, it will not hurt to have both types on your credit report.
Of course, unsecured means that you have a good credit score and credit history, so the more unsecured credit you have the better This will come over time.
Now!………. Don’t think you have to stress yourself about this. If you’re just starting to build your credit or have bad credit, you have a secured credit card.
But remember, soon enough they’ll offer you an unsecured credit card. Hang in there, make your payments and keep your balance low. No worries!
Before you know it, with a little time and patience, you’ll have a nice mixture of both!
This is what you want to have a healthy credit score!