What Is Unsecured Debt?

Not all debt is the same. One factor that differentiates different kinds of debt is whether that debt is secured by collateral. Understanding what unsecured debt is and how it differs from secured debt can help you make smart decisions as a user of credit.

Let's take a closer look at unsecured debt, when you might use it, the advantages and disadvantages, and how it can help you achieve your financial goals.

How unsecured debt works

The main characteristic of unsecured debt is that, unlike secured debt, it doesn't involve collateral. Collateral is an asset that you pledge to the lender as a condition of borrowing money. With unsecured debt, there's no collateral involved. The money you borrow isn't secured, or collateralized, by any piece of property.

Unsecured debt works similarly to most other types of debt. Generally, once you're approved for a type of unsecured debt, whether it's an installment loan or revolving line of credit, you're obligated to repay it according to your loan agreement. However, if you can't pay an unsecured debt back, you don't risk losing any collateral.

• Installment loans, such as personal loans and student loans, tend to have fixed repayment lengths, typically lasting two to 10 or more years. Most personal loans have fixed interest rates, while student loan interest rates are typically variable.
• Revolving credit, such as credit cards and personal lines of credit, commonly allow you to borrow money continually until you reach a set credit limit. They have minimum monthly payments and, likely, variable interest rates. However, fixed-rate credit cards do exist, even though rates can change periodically.

With unsecured and secured debt, the cost of borrowing is typically expressed as an APR (annual percentage rate). APR factors in both the interest rate and any upfront fees the lender may charge, such as origination fees. Because an unsecured debt isn't secured by collateral, the lender takes on more risk in lending you money. This typically translates to a higher interest rate, relative to secured debt.

Learn More: What Is a Personal Loan Origination Fee?

Unsecured vs. secured debt

Laura Adams, an award-winning personal finance author and one of Empower’s “Top 50 Women in Personal Finance,” says, “Getting a secured debt is typically only required for large loans, such as financing a home or vehicle. While an unsecured loan charges higher interest than a secured debt, it’s generally easier to get.”

When you compare unsecured debt vs. secured debt, keep in mind the potential tradeoff. Unsecured loans generally require higher credit scores because there’s no item a lender can repossess if you don’t repay the debt. Lenders make up for the risk in part by charging higher interest rates and sometimes by raising eligibility requirements, such as requiring higher credit scores. 

If you have bad credit, it might be easier to qualify for a personal loan if you put up collateral, but you also risk losing the collateral if you default.

Learn More: Secured vs. Unsecured Personal Loans

Examples of secured debt

With many secured debts, an item you intend to purchase with the borrowed money serves as the collateral. In other cases, the collateral serves only as a way to improve your creditworthiness. Examples of secured debt include:

• Secured personal loans
• Home equity loans
• Home equity lines of credit
• Mortgages
• Most auto loans
• Title loans
• Pawnshop loans

Examples of unsecured debt

You’re more likely to encounter unsecured debt on an everyday basis. Examples of unsecured debt include:

• Most personal loans, including debt consolidation loans
• Most credit cards
• Student loans
• Payday loans
• Buy Now, Pay Later (BNPL) loans
• Cash advance apps and credit card cash advances
• Retail store credit accounts
• Money borrowed from family and friends

What happens if you don't pay unsecured debt?

Defaulting on a secured debt could mean losing the specific asset that you used as collateral — such as having your car repossessed or your home foreclosed. Although unsecured debt doesn't involve collateral, you could still face financial consequences if you don't pay. The penalties can include:

• Late payment fees, which vary by lender
• Penalty APR or deferred interest (for credit cards)
• Having the default reported to the credit bureaus, which can damage your credit score

If you don't pay off your debt to a creditor or a collection agency that purchased the debt, they may sue for the balance and additional fees, like attorney's fees and collections costs. If a creditor or collection agency wins a judgment against you, it may be able to garnish your wages, freeze your bank account, or place a lien on your property.

You can find out whether your credit report was affected by a late payment by checking AnnualCreditReport.com. Credit bureaus Experian, TransUnion, and Equifax offer free weekly online credit reports. You can also check your credit score with Credible's free credit monitoring tool or find out if your bank or credit card company offers free credit score monitoring.

While student loan debt is unsecured, you likely signed a promissory note as part of your loan agreement. If you don't repay the loan, the lender may take legal action to get its money back. Wage garnishment and taking all or part of your federal income tax refunds are possibilities.

What are the requirements for unsecured debt?

Requirements to take on unsecured debt vary by lender and loan type. For example, some BNPL lenders don't check your credit score. However, lenders typically look at factors including:

• Credit score: Credit score requirements vary by lender. However, lenders typically prefer higher scores than they would for a similar secured loan.
• Credit history: Lenders use your credit report to see your repayment history, accounts in collection, foreclosures, whether you've filed for bankruptcy, repossessions, and more to determine how likely you are to repay the loan.
• Current debts: Lenders consider what you currently owe and your repayment history.
• Debt-to-income (DTI) ratio: This ratio compares your monthly debt payments to your monthly gross income. Many lenders prefer DTI ratios below 36% for personal loans.
• Employment history and income: Lenders want to see steady employment and income.

Related: What Are the Requirements for a Personal Loan?

How to eliminate unsecured debt

Here are some strategies to get rid of unsecured debt:

Pay off the debt

Three ways to approach paying down unsecured debt include:

• Budgeting: Work on cutting discretionary spending to free up funds for debt repayment.
• Snowball method: Pay the smallest debts first for quick wins and more momentum.
• Avalanche method: Target the highest-interest rate debts first to pay less on interest.

Debt consolidation

You can use a personal loan to consolidate multiple debts, ideally at a lower interest rate than what you're currently paying. You might also consolidate debts to a balance transfer credit card with a 0% introductory APR to save on interest. The trick is to pay off the balance before the 0% APR offer ends and the card's regular APR goes into effect. Depending on the card, you might also have to pay a balance transfer fee of 3% to 5% of the amount being transferred.

Adams also mentions that paying off the debt with a lower-rate secured debt like a home equity loan or home equity line of credit (HELOC) can be wise. However, she cautions that defaulting on this loan puts you at risk of losing your home.

Compare: HELOC vs. Home Equity Loan: How to Decide

Negotiate with your lender

"If you're experiencing financial hardship, contact your lender to discuss possible options, such as loan modification or forbearance," says Adams. You can also discuss with your lender the possibility of refinancing the loan for better terms.

Related: How To Negotiate Credit Card Debt: A Guide

Debt management plan

Talk to a nonprofit credit counselor about establishing a debt management plan (DMP) with your creditors. Credit counselors may be able to negotiate on your behalf to eliminate fees, lower monthly payments, and/or lower interest rates. Instead of paying your creditors directly, you would make one monthly payment to the counselor who then disburses the funds.

Using a DMP as opposed to a debt settlement company can protect your credit score and well-being. Debt settlement typically requires that you stop making payments entirely which can result in severe credit damage, collection calls, and even lawsuits.

File for bankruptcy

Bankruptcy should be a last resort because it stays on your credit report for up to 10 years or longer. The two main types of bankruptcy are:

• Chapter 7 bankruptcy: Discharges most unsecured debts
• Chapter 13 bankruptcy: Sets up a court-mandated repayment plan over several years

Ekenna Anya-Gafu, a certified financial planner and founder of Pacific Canyon Investments, says that a first step can be asking yourself why you’re struggling to pay off your debt. Is it because of emergencies that keep popping up or because interest keeps you from making progress? 

If it’s the former, he advises carefully analyzing your budget to see if there’s a way to address and prevent these kinds of expenses from happening. 

“If it is more the latter or you just can't pay the balance down because of interest, then I recommend trying to find a way to consolidate. This will allow you to get a lower rate and lower payments, expediting how quickly you can pay down the loan.”