There’s no doubt that debt is a part of life at one time or another. Even though the word evokes dread in many people, debt isn’t necessarily always bad. Part of understanding that you don’t necessarily need to fear debt is understanding the difference between when your debt is secured or unsecured.
What makes a debt “unsecured”?
Unsecured debt is any type of money you owe that isn’t based on an asset. Since there are few debts you can reasonably tie to an asset, unsecured debt includes but is not limited to:
- Credit card debt
- Medical bills
- Personal loans
- Student loans
These types of debt are risky for a lender since they’re not based on any tangible asset that they can take from you if you stop paying. This means they are sometimes difficult to get if your credit is bad and usually come with high interest rates. The primary reason that unsecured debt carries a risk for the lender is that the borrower can declare bankruptcy and shrug off the debt.
What makes a debt “secured”?
A secured debt, since it’s based on tangible collateral, can be repossessed by the lender, even in certain forms of bankruptcy. An example here would be if you have a mortgage and default, your bank can take control of the home. Similarly, vehicles bought with a loan can be taken by the lender if you fail to make your payments. Essentially any debt that is based on the fact that the lender can take something from you to cover it is considered “secured”.
Comparing secured and unsecured debt
Both types of debt have advantages and disadvantages. With unsecured debt, there are certainly a few “pros”:
- The threshold for obtaining a line of unsecured debt is lower than a secured debt.
- Bankruptcy will wipe out most unsecured debts (except for student loans).
- Having open, unused lines of credit are great for building your credit rating. This is, of course, easier to do with unsecured debts like credit cards.
That said, there are a few things to keep in mind. Typically the interest rates of unsecured debts are fairly high, resulting in more money paid back the longer it takes you to pay the debt off. There’s also the fact that too much unsecured debt will hurt your credit score.
Also, if you end up using bankruptcy to remove unsecured debt, it will affect your ability to get more unsecured debt for a few years into the future.
And one of the most important things to keep in mind is that unsecured student loans cannot be written off in bankruptcy.
Ultimately it’s safer for the consumer to have unsecured debt because it can be removed using bankruptcy. That said, this type of debt can easily snowball if you’re not careful. This means it’s often easy for one credit card to turn into several, and then you end up in a debt spiral.
Secured debt has its own pros and cons, too.
Secured Debt Benefits
First of all, debt like a mortgage is very rarely seen as a negative and can actually improve your credit. Even though you might owe a lot of money on your mortgage, it’s still seen as a considerable asset. Real estate is valuable, particularly in densely populated cities.
Secured debt often has significantly lower interest rates due to the stability of the investment. This is because the debt is simply less risky, so the lender is more inclined to offer competitive interest rates.
Also, secured debts improve your credit rating just by having them and being on-time with your payments.
Lastly, in difficult times, it is much easier to find assistant programs to help with secured debts like a home than with unsecured debts.
Secured debt cons
- If you fall behind on secured debt like your home, the bank can repossess it and sell it to cover the loan.
- Secured debts can often have variable interest rates, depending on the market. Always look for the option to get a fixed interest rate on major purchases like a house or car.
- There is the potential that if you use your collateral for a consolidation loan that you will go back to irresponsible monetary decisions. This is due to the low interest rate and the fact that you might not feel trapped by the now-consolidated debt.
Different loans, different behaviors
Because unsecured debts have such high interest rates, you should do your best to pay them off as quickly as possible. This means any extra money each month should be going to the balances, highest to lowest rates first.
This is in contrast to a secured debt, where the loan is often so large that you have years or decades to pay. This means your payments are largely fixed, so paying significantly extra doesn’t mean much.
This doesn’t mean you shouldn’t pay extra – even a few hundred dollars extra towards the principal of a mortgage per year can save you in the long run. It simply means that if you have extra income to pay down debt each month, throw it at your unsecured debts. In particular, you should be treating any student loan debt as if it were literally on fire.
Student loan debt has no collateral to be repossessed but it also can’t be written off. Additionally, it often has relatively high interest rates. If you’re in a financial bind, you should always prioritize your secured debt payments first, as losing your home is not an option.
After that, though, pay your student loans first before your other unsecured debts, because if push comes to shove, you can declare bankruptcy to get your head above water again.
If the interest rates of your student loans and the payments are beginning to be too much, it’s worth looking into refinancing them. You have multiple options for refinancing student loans, but the most common ones are:
- Private loans from banks
- Major student loan consolidation companies
- If you’re working for a governmental agency, you can refinance through the Public Service Loan Forgiveness program (federal loans only)
Private bank loans are large loans that pay off the various small loans you might have from different lenders. This is beneficial because often when you graduate you have to pay back several lenders for different amounts and keeping track can be cumbersome. Likewise, you might end up with a lower interest rate by consolidating all into one big loan.
The Public Service Loan Forgiveness program is designed to consolidate all of your federal loans and forgive your debt after 120 payments are made. This only applies to certain government agencies but applies to certain municipalities (like HUD programs), and most state and federal employment. This includes working for public schools and universities. The one concern with this program is that when your debt is wiped out, the amount is often treated as income, so you might find yourself in a whole new tax bracket for the year your loans are forgiven.
Finally, there are companies that specifically only consolidate student loans. They work with lenders to get you a really low rate while consolidating all of your outstanding loans. One of these companies is Lendkey.
Help from LendKey
Lendkey uses a completely digital presence to automate the majority of the lending and consolidating process. This reduces the amount of time and money lenders have to invest in these processes and in the end, it saves you money. If you’re struggling with payments, have a large amount of unsecured debt, or simply want to consolidate your student loans with better interest, check Lendkey out.
No matter what route you choose, consolidating your student loans is a big step to financial independence. Consolidation will often save you a significant amount of money each month, or at least lower your payments. Lower payments on student loans means more money to throw at unstable, unsecured debts to get them paid off as quickly as possible.
Prioritize your debts and pay them off efficiently
When you go to pay your debts each month, consider how efficiently your money is being paid out. Prioritize your secured debts first, but don’t worry about paying more than the minimum. Also, look at your highest interest unsecured debts and pay them down as quickly as possible. Allocate the extra funds from not having to pay those down to the next highest interest rate. And seriously – treat unsecured debt as if it were a rotten egg stinking up your home (i.e. get rid of it ASAP!)
Lastly, consolidate your looming student loan debt through the PSLF program or a borrower-focused lender like Lendkey to dramatically reduce your monthly payments. This will also make keeping track of your loan payments much easier.
Secured or unsecured, debt can be overwhelming, but it doesn’t have to be. Create a budget, pay a little extra when you can, and trust that you WILL see financial freedom eventually. It will take time and hard work, but the relief you’ll find at the end is unlike any other. Just keep moving forward and you’ll get there!
Do you have any helpful tips or tricks for paying off debt that I didn’t cover here?
I’d love to hear about it in the comments!