There are two types of consumer loans: secured debt and unsecured debt, based on the existence of collateral to support the loan. This blog looks at the difference between secured debt and unsecured debt, secured debt examples, and types of unsecured debt.
What is secured debt?
Secured debt uses collateral, reducing the risk of non-repayment to the creditor. The borrower agrees to put up an asset as collateral or surety for the loan until the debt is fully repaid. It is then in your interest, as the borrower, to repay the loan and keep your collateral.
The most common secured debt examples are property loans and vehicle finance, where the collateral is represented by the home or the car. Some bank loans and credit lines can also be secured.
Pros: Secured debt is guaranteed by its collateral. Creditors have an asset that covers the loan. Thus this type of loan carries less risk for the lender. You benefit from lower interest rates than unsecured credit.
Cons: Defaulting on secured credits will impact credit rating negatively, which means you may struggle to receive credit in the future. Also, you stand to lose the collateral asset, home or vehicle, due to non-payment.
What is unsecured debt?
Unsecured debt has no collateral backing. The creditor extends the loan without collateral, based on the borrower’s creditworthiness and promise to repay the loan. Thus, unsecured debt poses a higher risk for the lender than secured debt, which means a higher interest rate for the borrower.
Unsecured debt examples include the majority of smaller loans such as credit cards, retail store accounts, personal loans and micro-loans. Generally, you can apply for unsecured credit to cover all kinds of household, health, education, travel and leisure expenses.
Pros: Unsecured debt is processed faster than secured debt. The waiting time for approval is shorter, so you can access the money faster. Also, since there is no required collateral, you cannot lose assets when defaulting on the repayments.
Cons: Unsecured debt carries more risk to the lender. You will pay much higher interest rates than those provided with secured credit. Furthermore, creditors cover some risks by granting smaller amounts of unsecured loans than those obtained with secured credit.
Is a mortgage secured or unsecured debt?
A residential mortgage is a secured debt. The property in itself is the security or collateral offered to the bank or lender in exchange for granting the home loan. When you default on your bond, the creditor sells the property to cover the loan amount.
Is a car loan secured or unsecured debt?
A car loan is a secured debt. As with property loans where the home stands as collateral, the vehicle is the security for the car loan. Defaulting on the loan means that the bank or vehicle finance provider is entitled to sell the car to cover the loan amount.
Are student loans secured or unsecured debt?
Student loans are generally unsecured debt, as with most educational loans. The student and the income-earning parents do not need to provide any asset or collateral in exchange for the loan. However, this type of loan represents a higher risk for the lender. If you default on student loans, the creditor cannot take back your education. Hence, there is a significantly increased interest payable on student loans, thus higher repayments for the borrower than with any other household debt.
Are credit cards secured or unsecured debt?
Credit cards are unsecured debt. There is no collateral involved, and the credit approval is relatively quick. However, as with all unsecured debt, the interest rates are higher than those of secured debt. There is also a higher risk of overspending on credit cards until you may be unable to meet the minimum repayments.
The bottom line: How safe are unsecured loans?
Almost 80% of South Africans seek expensive unsecured loans to meet monthly financial obligations, revealed a survey by fintech platform PayCurve last year. Personal loans, credit card and retail accounts are easier to get approved but add immense pressure on finances and debt management. Poorly managed unsecured loans can lead to over-indebtedness and the general inability to repay escalating debts.
It is not uncommon for the average employed South African to fall behind with debt repayments on unsecured loans. If you struggle with multiple high-interest credit accounts and personal loans, making those monthly payments on time and in full becomes increasingly difficult and stressful.
A debt counsellor may recommend a debt review process to assess your unsecured debt situation and suggest an alternative, affordable repayment plan. Through debt consolidation, you may reduce all your debts into one monthly account, simplifying repayments and easing the debt burden considerably. For more information, consult an ezDebt adviser.
Our professional ezDebt advisers can help you stay on track with debt repayments through a quick and affordable debt review. All our debt counsellors are registered with the National Credit Regulator (NCR). Get in touch at www.ezdebt.co.za.