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What is unsecured debt? | How it Works, How to Eliminate

1 unsecured debtDebt – the very word doesn’t go down well with anyone.

Majority of the people are forced to borrow money for something or the other, at some point of time.

Debt by itself is not a bad news but one should be wise and plan their borrowings and repayments according to their financial resources.

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What Are The Types Of Debts?

Debts are nothing but the money borrowed from a lender, also known as a creditor. The lender can either be an individual, a bank or any other financial institution that has the legal capabilities to lend and collect money from the borrowers.

When a creditor lends money, he does so only on a calculated basis. The debt can either be secured or unsecure. Both types of debts are very well known and are widely used by the debtors all over the world.

What Are Secured Debts?

Secured debts are those which are lent out against some collateral. The lender is safe from default payments as he has collateral against the money lent. If the borrower defaults his payment, the creditor can seize the collateral to cover his loss or recover his money.

These loans are easier to avail than unsecured debts as the creditor’s risk is limited and covered by the borrower’s asset. If not an asset, the borrower can even have a co-signer for the loan and the creditor can collect the money from the co-signer in case of a default in payment.

What Is Unsecured Debt?

While the concept of lending money against some security is very common, there are also debts that are lent out without any security. When a creditor lends money without taking any collateral for the loan, it is termed as an unsecured debt.

The money is lent purely based on the word and assurance given by the debtor. However, the borrower must have a good credit score and a close to flawless credit history to avail of an unsecured debt.

Unsecured debts have a higher rate of interest when compared to the secured debts. This is to cover the risks undertaken by the lender. If the borrower defaults his payment, the lender can sue the debtor for the remaining amount but this is a very time consuming process. Hence, the lender charges a higher rate of interest to recover his money as early as possible.

It is not easy to get an unsecured debt. Each financial institution has a different set of rules and interest rate slabs for unsecured debts. Despite a good credit score and credit history, the lender reserves the right to give an unsecured debt. 

Secured Vs Unsecured Debt

Now that you know what secured and unsecured debts are, here is a table to help you understand the difference, better.

Secured Debts

Unsecured Debts

Given against some asset as a collateral

Given against the word of the borrower

Interest rates are lower

Interest rates are higher

Lender’s risk is low and limited

Lender’s risk is high

Can be recovered easily by seizing the collateral in case of defaults

Recovering a defaulted loan involves a lengthy legal procedure

Borrowers with low credit score can also get a secured loan

Borrowers need to have a good credit score and credit history

Rates of interest and lending rules and regulations are pretty much fixed for all borrowers

Lender reserves the right to give an unsecured debt and the interest rates and requirements can vary from person to person

Not very difficult to get

Not very easy to get

 

1 unsecured debt consolidation loan bad creditWhat Are The Types Of Unsecured Debts?

The different types of unsecured debts are:

Business LoansBanks offer credit line facilities to many businesses. This allows the business to withdraw more money than what is in the account. The overdraw facility can vary from bank to bank and from customer to customer. The banks fixes the overdraw limit based on the credit score and credit history of the customer.

Businesses avail of this facility, to protect themselves from unexpected losses that can cripple their business. Businesses can halt due to lack of payments. In order to avoid such a crisis, businesses use unsecured debts.

Personal Loans – These loans can be availed for any reason, for any amount. It can be used for business or even vacation purpose. Higher the credit score, lower is the rate of interest charged. Identity proof such as a license or social security card is required by the lender. He will also require proof of current employment and income details.

Credit Cards – The most common type of unsecured debt. Various banks offer various credit card plans based on the customer’s credit score and the balance in their bank account.

Usually, the rate of interest charged on the card is around the same rate, for all customers. The difference is in the upper limit for your borrowing. The rate of interest increases when a payment is not made on time.

Student Loans – Are student loans a secured debt? No, both the government aided and private student loans are given without any collateral. These loans are given out purely on the merit of the student and their promise to repay the loan. Though federal loans are backed up by the government, private loans are not.

The rate of interest charged on a private student loan is higher and the repayment options are not as flexible as in federal loans. The student is expected to staying paying back his loan, once his course is completed. However, the loan accrues interest even when the student is still studying.

If a student is unable to repay his private student loan as soon as he finishes his course, he cannot be forgiven from paying the loan. He can either consolidate the loan and take out a fresh loan at a lesser interest, or renegotiate with his lender for a longer term or lower interest rate.


How Are Unsecured Debts Collected?

Unlike secured debts, where the lender has an asset as collateral, unsecured debts only have the word of the borrower and his signature. If the borrower defaults his loan payments, the lender does not have any asset to sell and recover the lent money.

The creditor or the lender can either employ a collection agency to collect the due amount or sell the debt to a collection agency. The default in payment is reported to a credit reporting a credit reporting agency, and this negatively affects the credit score of the debtor.

The lender can also file a lawsuit against the borrower and the court may force the debtor to repay using some of his assets. Though the legal proceedings will take time and the creditor will not get his money immediately, it will eventually reach him through the court.

What Is Loan Consolidation?

Very few people have a single loan to repay. Many have a number of loans and outstanding debts such as credit card payments, to make on time, in order to avoid unnecessary actions against them. When you have a number of debts to repay, keeping track of it along with the various rates of interests and payment dates can be very confusing and complicated.

Multiple loans can be consolidated into one single loan with a lower rate of interest. If there are a number of loans, the average rate of interest is usually applied to the new consolidation loan. When all loans are combined into one new loan with a single rate of interest and payment date, it is called loan consolidation.

Is Unsecured debt Consolidation Loan With Bad credit, Possible?

Unsecured loans are not easy to get. One needs to have a good credit history and a strong credit score to be granted an unsecured loan. Every lender has their own set of criteria and verification system to decide if a person is eligible for an unsecured loan.

Unsecured loans such as credit card bills, medical bills, etc, can always be combined into a single debt by taking out a new loan and paying off the existing ones with the money. When your credit score is low or you have a history of bad credit, it is very difficult to get a new loan to consolidate your unsecured loans.

However, if you are willing to pay a high rate of interest in a short time, you may find a few options. Unsecured loans usually come with a short term for repayment.

[PDF]Understanding Debt Consolidation – US Mortgage Corporation

1 secured vs unsecured debtWhen Should You Consolidate Your Unsecured Loans?

Consolidating your unsecured loans may seem like a good idea as you will get more time to repay the money. However, it will not help you to get rid of the loan or get out of paying back the money. It only buys you some time, usually at a high rate of interest.

You can consolidate your unsecured loans in the following situations:

  • If you are expecting some money in the near future, that can be used to pay off a major part of your new loan.
  • If there are too many small debts with varying interest rates, that is making it difficult for you to keep track of.
  • If you don’t want to risk defaulting a payment and letting it affect your credit score.
  • If you are building up your credit history for future borrowings.
  • If your banker is willing to give you a good deal. If the new rate of interest is equal to or lower than the average of your existing rates of interest. This will reduce your overall outstanding amount, thereby reducing you total debts.

How To Eliminate Unsecured Loans?

There are a number of ways one can eliminate or consolidate their unsecured loans.

Friends And Family

Ask your friends and family to lend you at least a major portion of your debt if not enough money to pay off all your debts. You can pay them a good rate of interest, higher than what they would get for a bank deposit. This will be lower than the interest you would pay, if you borrow this money from a financial institution. Thus a win-win situation.

Credit Card Consolidation

Consolidate your credit card debts by negotiating with your current lender. Ask them for better rates, longer terms or more benefits in terms of cashbacks, rewards, etc, for using their card. If your current lender is not ready to budge, check with other credit card companies. In this highly competitive market, you are sure to get a good deal.

Professional Help

Seek the help of a professional. A debt consolidation company or an advisor will be able to assess your financial situation. They will be able to advise you as to how to deal with the debts and if and what debts you must consolidate.

Extra Payments

Instead of making a single monthly payment, pay more every month. Extra payment once in few months can also help. This will not only reduce the principle amount but also the rate of interest. If you get any extra money such as a lottery or inheritance, use it to pay off your debts.

Debt Consolidation Programs

These programs will help you analyse your financial situation and come up with a plan to pay off your debts effectively. They will tell you how much money you should pay your debtors each month, in order to be debt free sooner rather than later.

These programs can also help you prioritize. Some loans have a higher interest rate than others. It is always advisable to tackle these high interest loans first.

Debt Consolidation Loan

The most common method of consolidating unsecured debts is to bundle up all the debts into a single loan. This loan generally has an interest rate that is the average of all the debts you are consolidating. Try to get a loan for a rate lesser than what you were paying as it will reduce your overall debt.

Conclusion

Unsecured loans can be a boon to those who can repay their debts on time. It gives them immediate money without collateral. This is good growth at a low risk. However, if one cannot pay the debts on time, unsecured loans will only worsen the situation. One can get stuck with very long term debts due to the lack of effective financial management.

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