Understanding the difference between secured and unsecured debt is not only an important factor in becoming financially savvy, it’s also an essential element of sound financial planning.

Whether you are taking out a loan or filing for bankruptcy, you will quickly find yourself in a crash course on he subject. But by knowing about secured and unsecured debt before you absolutely have to, there is a better chance that you can avoid many of the financial mistakes made by those who don’t understand either or their relationship to one another.

What is Secured Debt?

Secured debt is surprisingly easy to understand. Essentially, secured debts are debts that are tied to your ownership of some property. Should you default on repaying a secured debt, the lender will have recourse in the form of seizing the property to which you debt was linked. Mortgages are outstanding examples of secured debts because if you can’t repay the loan, the bank that provided the loan can take possession of your house. Other examples of secured debts are loans for the purchase of automobile or even a line of credit to purchase furniture.

What is Unsecured Debt?

Unsecured debt can best be described as the practice of walking a tightrope without a safety net. If you fall, there’s nothing to catch you. From the perspective of a lender offering unsecured debt, this is the best analogy to describe their risk. Basically, anyone who defaults during repayment has no tangible possession to forfeit in return.

Credit cards are a great example of unsecured debt. That is, no collateral is linked to the debt. However, many lenders are beginning to require new cardholders to sign a security agreement that, in the fine print, outlines that your property could be claimed as collateral if the credit card ever falls into default status.

Assessing Unsecured vs. Secured Debt

When taking inventory of personal debt or estimating what you can still afford to borrow, it’s essential to understand the difference between secured and unsecured debt. Some basic pointers:

• Thoroughly inform yourself about any loan you obtain (secured or unsecured). Read the fine print and understand the terms you are agreeing to.

• Don’t forget that secured debt is a loan backed by collateral. What you buy from borrowing could end up belonging to your lender (possibly along with other possessions) if you default on your loan payments.

• Credit card debt and other revolving charge accounts are primary examples of unsecured debt.

• Secured loans often have lower interest rates than unsecured debt.

Ultimately, regardless of your financial situation – strong or shaky – knowing what types of debt you have already accrued and understanding those that you may acquire is an imperative component of lasting solvency and learning how to properly manage debt.

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