You might think that all your debts are equal. In your mind, there might not be any difference between your auto loan, student loan, and credit card bills.
But there is one major difference: Some of your debts are unsecured, and some are secured. It’s important to know the difference if you run into a financial crisis and you don’t have enough money to pay all your bills on time. (See also: Pay These Bills First When Money Is Tight)
If you stop paying secured debt, you might lose your home, car, or other assets. If you stop paying unsecured debt, your credit score will take a major hit, but you won’t lose your shelter or your car.
Secured vs. unsecured debt
Secured debt is tied to an asset. Think of mortgages and auto loans.
In a mortgage, the money you borrow is connected to your home, which your lenders consider collateral. If you stop making your payments, your lender can start foreclosure proceedings to take possession of your home.
In an auto loan, your car serves as collateral. If you stop making payments on this debt, your lender can take possession of your car.
The collateral on secured debts is a way for lenders to protect themselves when passing out large loans. Borrowers aren’t as likely to stop making payments if they know doing so could cost them an asset. And if borrowers do stop making payments, lenders can recover some of their losses by taking possession of the collateral and selling it.
Unsecured debt does not have any collateral behind it and is not tied to any asset. The most common kind of unsecured debt is credit card debt. Student loan debt and medical bills are also examples…
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