- Unsecured debt is a debt in which the borrower does not provide collateral against the loan.
- Examples of unsecured debts are credit card debt, personal loans, medical debt, etc.
- Unsecured debts usually offer greater returns than secured debts.
What is an Unsecured Debt?
Unsecured debt is a debt in which the borrower does not provide collateral against the loan. Unsecured debt exposes the lender to credit risk, because in case of default by the borrower, the lender has no collateral to recover the borrowed amount from. The unsecured debt is risky, in turn, commands a higher interest as compared to secured debt which is secured by collateral.
Lenders may sue the borrower to receive access to some assets, if the borrower refuses to pay the amount back.
Types of Unsecured Debt
· Credit Card debt: Credit card debt forms the most widely spread form of unsecured debt. One thing to remember is that all the credit cards are not unsecured. There are some secured credit cards that require an initial deposit equal to the spending limit.
· Personal loans debt: Personal loans are funded by banks and usually have a cap. It can be used for a variety of purposes ranging from a vacation to funding a start-up.
· Private student loans: These loans are another example of overwhelming debt. These debts provide students with opportunities to learn and concentrate on their studies.
· Peer to peer loans: These loans are provided to one individual by another. These loans often happen between family members, relatives and friends.
· Medical Debt: Medical bills are a very unique type of unsecured debt. In other forms of debt, a person usually decides to do something that requires debt but nobody wants to fall ill and get stuck under medical debt.
· Apartment Leases: When one falls behind in paying his/her rent, he/she gets indebted to the landlords. Landlord may decide to take action against you. But since no asset of yours is at risk, this debt comes under unsecured debt.
Unsecured Vs Secured Debt
As mentioned earlier, unsecured debts are those debts which do not have any asset backing them up. In contrast secured loans are those loans that are backed by an asset or a collateral. Secured debts are less risky but usually they offer less returns than unsecured debts.
Pros and Cons of Unsecured Debt
Advantages and disadvantages of unsecured loans can be described once we define whose perspective we are referring to. From a lender’s perspective, the biggest disadvantage is lack of collateral from the borrower. But unsecured loans also offer more return to the lenders and lenders can mitigate risk by properly analysing the financial background of the borrower. Even then, if the borrower defaults, lenders have an option to sue him/her and get access to some assets or accounts.
From a borrower’s perspective, the pros and cons of unsecured loans are:
· Shorter repayment term
· No asset risks
· Harder to get from the lenders
· Higher interest rates
· Generally lower borrowing amount allotted
Credit cards debts are on rise again, especially in America. At the start of year 2017, Americans have topped $1 trillion on their credit cards, which is highest since the year 2008 when the Great Depression happened.