There are two major types of debt: secured and unsecured. Knowing the difference can be important in managing your finances and prioritizing your debts. They are also treated differently when you file bankruptcy.10
Secured Debt
Secured debt is a debt that is secured by real property or other assets (collateral). Some common examples of secured debt are car loans and home mortgages. Often the collateral is the source of the debt, such as in a car or home loan. But the collateral can also be something unrelated to the debt if the lender requires collateral.
If you default (fall behind in payments or break the debt contract) on a secured debt, the lender has the right to take (repossess) the collateral that is securing the debt. For this reason, it is wise to give priority to making payments on secured debt so you do not lose your property.
When you file bankruptcy, you must either give up the property on a secured loan or continue to make payments on the debt. In a Chapter 7 bankruptcy, if the equity in the property does not exceed what the state allows you to protect, and you are current, you can generally keep paying on the debt and retain the property. In a Chapter 13 bankruptcy, you will generally pay off the debt through your repayment plan and will generally be able to keep all your assets.
Unsecured Debt
An unsecured debt is any loan not backed by an underlying asset. The most common type of unsecured debt is credit card debt. Other examples include medical bills, utility bills and any other type of loan or credit that was extended without a collateral requirement.
These debts generally have higher interest rates because the lender only has your word that you will repay and cannot repossess any property if you do not pay your debt. If you are looking to save money by making extra payments or pay off some of your debt, it is usually recommended to make extra payments on unsecured debt first so you can avoid continuing to pay the high interest rate.
In a Chapter 7 bankruptcy, unsecured debt is generally discharged and those creditors only get money if the court appointed trustee has collected assets from the debtor. (There are some types of debts that cannot be discharged. See next week’s post for more information.) In a Chapter 13, usually only a portion of the unsecured debt must be paid back as part of the repayment plan; the rest is discharged.