All debts are not created equal. Generally, there are two main types of debt: secured and unsecured. Within those types, you’ll see revolving and installment debt. Aside from the fact that you owe money, these types of debt are different. For instance, your mortgage is an example of secured debt, while an example of unsecured debt is your credit card. How best to handle each kind of debt varies.
What Is Secured Debt?
When you put up collateral for a loan, you’re dealing with secured debt. For instance, a mortgage is typically secured by your home and an auto loan is usually secured by your car.
If you get too far behind on paying a secured debt, the lender can seize the debt—foreclose on your home or repossess your car, for example.
If the seized collateral does not cover the debt you owe, the creditor may go after you in court to collect the rest of the money. For instance, if you owe $10,000 on your car, but it’s valued at just $6,000, the creditor may seek a court judgment against you to get the difference ($4,000).
Other types of secured debt include a home equity loan and a home equity line of credit (HELOC). In both cases, the debt is secured by your home.
Advantages of Secured Debt
Potential advantages of secured debt include:
- You may be able to borrow a substantial amount of money. Why? Because the lender knows they’ll get their money back, either by collecting your loan payments or by seizing your property if you fall behind on your loan payments.
- You may score a lower interest rate because a secured loan involves less risk to the lender than other types of debt, such as unsecured debt.
- You may qualify for an annual tax deduction on the interest paid on some secured loans, such as a mortgage or home equity loan.
Disadvantages of Secured Debt
Potential disadvantages of secured debt include:
- You can lose the property, such as a home or car, that secures the loan if you fail to make your payments.
- You’re typically borrowing money for a specific item, like a home or car, rather than being able to use the money for a variety of purposes, as you can with a personal loan.
How Best To Handle Secured Debt
Here are four tips to avoid trouble with secured debt or to get out of trouble:
- Always make your loan payments on time and pay at least the minimum amount due.
- Let your lender know if you’re struggling to keep up with the payments.
- Sell your property if needed. For example, if the lender is getting ready to repossess your car, consider selling it and paying off the debt. This can help you avoid the cost associated with repossession and prevent a negative mark from showing up on your credit report.
- Reach out to your lender if you’re having trouble making payments. For example, if you’re not able to make a mortgage payment, contact your lender right away. The lender may reduce your payments for a short time or put them on hold so you can catch up on your debt. Or the lender may even change the loan terms to lower the monthly payment.
What Is Unsecured Debt?
Unlike secured debt, unsecured debt is not backed by an asset such as a home or car. Instead, a lender lets you borrow money based on your creditworthiness (perceived ability to repay the debt). Common types of unsecured debt include:
- Most credit cards
- Medical bills
- Most personal loans
- Student loans
Since unsecured debt is not backed by an asset, a creditor can’t seize your property if you fail to make payments. But if you fail to make payments for too long, the creditor likely will report the missed payments to the major credit bureaus. In addition, the creditor may turn your debt over to a debt collector or seek a court judgment requiring you to pay the debt.
Advantages of Unsecured Debt
Potential advantages of unsecured debt include:
- You don’t need to own property, such as a car or home, to obtain an unsecured loan or unsecured credit card.
- Your unsecured debt isn’t backed by collateral, which means a creditor can’t seize your property if you fail to pay, without taking legal action.
- Your application for an unsecured loan or credit card may be approved more quickly than an application for a secured loan since these loans don’t require collateral.
Disadvantages of Unsecured Debt
Potential disadvantages of unsecured debt include:
- You’ll often be charged higher interest rates for unsecured debt than for secured debt. Lenders take a greater financial risk with unsecured debt and have no collateral to seize if you fail to make your payments.
- You may find it more difficult to qualify for an unsecured loan or credit card if you don’t have a solid credit history.
How Best To Handle Unsecured Debt
Here are a couple of tips for avoiding trouble with unsecured debt or getting out of trouble:
- Always make your payments on time and pay at least the minimum amount due.
- Reach out to creditors if you’ve gotten behind on payments. They may be willing to work out a repayment plan.
What Is Revolving Debt?
Revolving debt can be unsecured or secured. Credit cards are an example of unsecured revolving debt. Home equity lines of credit (HELOCs) are an example of secured revolving debt. A revolving account comes with a credit limit set by the lender.
With revolving credit, you can borrow against the credit limit over an indefinite period. The amount of available credit decreases as you make purchases and rises as you make payments. The minimum amount due each month fluctuates based on the balance amount.
How Best To Handle Revolving Debt
Here are three tips for avoiding trouble with revolving debt or getting out of trouble:
- Watch your spending.
- Pay in full each month. If you can’t, try to pay more than the minimum amount due each month and make every payment before the due date.
- If you’re having trouble paying back your debt, tackle higher-interest debt before lower-interest debt. Known as the debt avalanche method, over the long run, this can help you save money on interest charges.
What Is Installment Debt?
Installment debt is another term for non-revolving debt. Intallment debt refers to a loan that provides a lump-sum amount of money at the start of the loan. For instance, you might take out a $10,000 personal loan to consolidate existing debts. Each month, you pay a set amount of money (like $300), and that money is paid over a set period (like 36 months). These types of loans can be secured or unsecured.
Types of installment loans include:
- Auto loans
- Student loans
- Personal loans
How Best To Handle Installment Debt
Here are five tips for avoiding trouble with installment (non-revolving) debt or getting out of trouble:
- Pay on time, every time, and pay in full.
- Make payments every other week rather than once a month. By doing this, you can cut the amount of time it takes to pay off the loan and reduce the amount of interest you pay.
- Pay more money each month. You can pay off an installment loan more quickly by padding your monthly payment. For instance, if you’ve got a car loan with a monthly payment of $250, you might tack on another $50 to bring each payment to $300.
- Make one extra payment each year. If you don’t feel comfortable making payments every other week or bumping up the amount of each monthly payment, consider making one extra payment each year. This can decrease the length of the loan and can decrease the amount of interest you pay.
- Refinance the loan. If you can score a lower interest rate, consider refinancing the loan to shrink the length of the loan and shrink the amount of interest you pay.
Having Trouble Paying Debt? Consider Debt Relief
If you’re having trouble paying your debt and your creditors won’t develop a repayment plan for you, consider contacting a credit counseling agency or another debt relief organization. A credit counseling service can, for instance, help you create a budget and come up with other solutions for your debt issues.
One of those solutions could be a debt management plan. Under one of these plans, a credit counseling agency develops a payment arrangement in conjunction with unsecured creditors. These creditors often agree to ease your financial burden by lowering your interest rate or waiving fees. With a debt management plan, you make monthly payments to the credit counseling agency, which then divides that money among your unsecured creditors.
Another avenue for coping with a pile of unsecured debt is to enlist help from a for-profit debt settlement program. However, this is a costly and risky alternative that’s generally an option of last resort. These companies negotiate with creditors to settle your debt with a lump-sum payment that’s less than what you owe.
To make the lump-sum payment, you set aside a certain amount each month. That money is transferred into an account that grows until there’s enough cash to pay the settled debt. Keep in mind that these programs frequently tell their clients to stop making monthly payments directly to unsecured creditors, which can cause a negative mark on your credit. Plus, you might end up being charged late fees and penalties by those creditors.
Knowing what types of debt you have can help you develop a better strategy for managing your debt. Plus, having different types of credit, such as revolving debt and installment debt, can benefit your credit. The mix of credit types makes up 10% of your FICO credit score.