What is secured vs unsecured debt
There are two types of debt: secured and unsecured debt. Understanding which debt is secured and which is unsecured is important as they affect you differently, particularly if you default in your payments.
Unsecured Debt
Unsecured debt is the most common form of debt. It relies on the borrower’s credit worthiness and their perceived ability to repay the debt. Unsecured loans have no form of collateral linked to the debt. Lenders of unsecured debt will rely more heavily on your credit scores and debt-to-income ratios when evaluating the amount of debt to grant you. Common forms of unsecured debt include:
- Credit cards
- Personal lines of credit
- Student loans
- Payday loans
- Utility bills
- Gym memberships
- Loans from family and friends
Unsecured loans usually have a higher interest rate than the secured loans. If you default on the loan, the lender will usually take legal action, turn the debt over to a collection agency and/or report the default to the credit bureau which will negatively affect your ability to obtain future unsecured debt.
Secured Debt
Secured debt is a form of debt where you provide an asset as collateral to guarantee the loan. If a default occurs in the loan agreement the lender will have the right to seize the asset, sell it and recoup the funds owed. If there is a surplus amount after the realization, then the lender will forward the excess funds to the borrower. If there is a shortfall after realization, then the debt will become an unsecured debt for the balance owing.
Secured debt will usually have a lower interest rate since the lender has reduced risk of loss, because they have the asset as collateral. Lenders will usually require certain covenants to be included in the loan agreement which you will have to perform, such as maintaining insurance coverage on the asset and keeping the asset in good condition. Common forms of secured debt include:
- Mortgages on real estate
- Car loans and leases
- Secured lines of credit
- Secured credit cards
Other types of secured debt include certain types of unsecured debt, that by law, can be converted to secured debt. They include debt for:
- Unpaid property taxes
- Unpaid condominium fees
- Unpaid income taxes
How the different types of debts are affected in a Bankruptcy or Proposal
In a bankruptcy or consumer proposal most of your unsecured creditors will be covered and eliminated. There are certain types of unsecured debt that will survive an insolvency proceeding, such as certain student loans, support payments, and court fines.
For secured debt, if your debt is in good standing, most secured creditors will allow you to retain the asset that forms the collateral on condition you continue to pay the debt. When proceeding with one of the insolvency options, your ability to pay a secured creditor should improve as you will be eliminating your unsecured creditors. On the other hand, if the secured debt is too burdensome then you can convert the debt to unsecured debt by voluntarily surrendering the asset(s) that is subject to the collateral to the secured lender and the debt would then be part of your insolvency proceeding.
To get a clear picture on how each type of debt will affect you in an insolvency proceeding, contact an MNP Licensed Insolvency Trustee. We will give you specific details on how each type of debt will be affected by your bankruptcy or consumer proposal, and the effect it will have on any assets you may own. Regardless of what type of debt you have, we’ll help you make an informed decision on how to unburden yourself financially.
