Secured Debt and Unsecured Debt:What Are They & What Are the Differences?

When dealing with debt, the consumer is often faced with unfamiliar terms, such as “secured debt,” and “unsecured debt.” Debt is debt, right? Well, not quite!

It’s important to understand the difference between debt that is secured and debt that is not. Each is dealt with in specific ways when accessing insolvency solutions to help get out of debt such as consumer proposals or personal bankruptcy.

What Is a Secured Debt or Loan?

First, let’s look at secured debts or loans. Simply put, these are debts that are legally attached to a particular object or asset (often referred to as the “collateral”), so that if the consumer defaults on the loan, the creditor has the right to seize the collateral, sell it, and be paid from the proceeds of sale.

A typical secured debt is a house mortgage. The financial institution provides the money to purchase of a home. The debt is secured against the value of the home so the bank is taking minimal risk by forwarding the funds for the purchase. If the consumer ceases to pay the mortgage as agreed, the bank can begin a process (varies by province) of collecting what is owed to them by forcing the sale of the house. If you are having debt issues, a Licensed Insolvency Trustee can help you navigate the provincial differences and how an insolvency process could affect your home ownership.

Another common example of secured debt is a car loan. In this example, the vehicle is the collateral. Depending on the terms of the loan, if the consumer defaults (does not meet the terms of the loan, typically by not making payments), the lender recoups its funds by repossessing the vehicle and selling it.

It is often easier for a consumer with a less-than-perfect credit rating to access secured loans than unsecured, simply because the financial institution or credit company is taking less risk – it is protected in case the consumer defaults by the value of the collateral.

 
What Is an Unsecured Debt or Loan?

Now, let us look at unsecured debt. Do you have VISA, Mastercard, or store credit cards in your wallet? That’s unsecured credit! Although there are other forms of unsecured credit, credit cards are the most common form today.

When you are approved for unsecured credit, the bank, credit company or store extends you credit based on information you have provided to show your credit-worthiness - such as proof of employment/income, credit score, etc.

The debt is “unsecured” because nothing material has been required as collateral. If you default on the terms of the loan or debt, the lender does not have the automatic right to seize and liquidate your assets to satisfy the loan.

What does the creditor do, then, if you don’t pay? There are many possibilities. They are likely to contact you frequently, by mail and/or phone, asking for payment. If you don’t pay for a longer period of time, they may contract with a collection agency, or sell the debt to them - in which case, you may be pestered  for payment by the collection agency.

A creditor or collection agency can also take you to court to try to collect the debt. The likelihood of this depends on the age and amount of the debt, as going to court can be expensive for all concerned. You are unlikely to be taken to court over a few hundred dollars.

If a creditor takes you to court over an outstanding debt and is successful, they will receive a court order that allows them to garnish your wages or seize and sell your assets.

How Does a Consumer Proposal or Bankruptcy Affect Secured and Unsecured Debt?

The differences between secured and unsecured debts are important when it comes to consumer proposals and personal bankruptcy. In general, both consumer proposals and bankruptcies are intended to deal primarily with unsecured debts.  Regardless of whether a proposal or bankruptcy is filed, valid secured creditors retain their right to liquidate their collateral for non-payment.    Here is a summary of how unsecured and secured debts are dealt with in each insolvency solution.

Secured and Unsecured Debts in a Consumer Proposal

A consumer proposal is often an ideal solution for debtors who have become insolvent (cannot meet their normal debt payment obligations) but have a steady source of income from which they can make regular monthly payments into the proposal for the benefit of their creditors.

Unsecured debts are included in a consumer proposal, and are completely discharged (with certain exceptions) when the terms of the proposal are completed (typically, with monthly payments for up to five years). This includes VISA, Mastercard, AMEX, and store credit cards, as well as payday loans and personal debts to friends and family.

Keep in mind that all of your unsecured debts must be included in your consumer proposal - you cannot pick and choose, as all creditors must be dealt equally and  fairly.

Your secured debts, such as house mortgage or auto loan are typically not affected by a consumer proposal, although these creditors are notified. If you keep making your payments as required, mortgages are typically renewed without incident.

If the monthly payments to a secured creditor are too burdensome, the proposal debtor can choose to give up the collateral (e.g. car) to the secured lender who will then sell it, and participate in the proposal (or bankruptcy) for any unsecured shortfall.

Secured and Unsecured Debts and Bankruptcy

Bankruptcy has more stringent conditions than a consumer proposal and can be more disruptive, but it is typically a speedier process and a robust insolvency solution.

Generally speaking, in a personal bankruptcy, the bankrupt person may be required to surrender their assets to the trustee for liquidation (and distribution of that money to their creditors).  However, there are several province & territory-set asset exemptions, and you will not be left with nothing.  In addition, the trustee is only required to take and liquidate an asset if there will be money left over to pay to unsecured creditors (i.e. there is equity).  For example, if the value of a car is less than the outstanding loan secured against it, the trustee is not obliged to liquidate it since after paying the secured creditor, there will be no money left for the unsecured creditors.  In cases like this, the bankrupt person has the option to continue with their car payments and keep the vehicle.  If there is some equity in the secured asset, the trustee may give the bankrupt person the option of paying into the bankruptcy the amount that would be recovered if the asset were to be sold – and the bankrupt person keeps the asset.

When the terms of the bankruptcy are completed and you are discharged (released), with only a few exceptions, the debts are considered cleared, and the unsecured creditors may never re-approach you for payment. After a period of some years, the record of the bankruptcy will be removed from your credit bureau file.  It is possible however, to take steps to rebuild your credit score even before the record of the bankruptcy has been eliminated from your credit report.  

 For More Information…

In this post, we have talked about secured versus unsecured debts and how they are dealt with in a consumer proposal and bankruptcy. We’ve also mentioned some exceptions and province-specific variations in what is exempt from being seized in a bankruptcy. If you are pondering these solutions, the next step is to make a free, no-obligation, confidential appointment to speak with a Licensed Insolvency Trustee.

You’ll feel better with your questions answered, and there is no risk. Contact a Trustee today!