What is Secured Debt?

When a consumer takes out a loan, many considerations go into the lender’s mind before deciding to offer money or not. A borrower’s income, credit history, location, use of the money and the value of his assets are often considered as major reasons. In fact, it is one of the major points to understand in the 5 C’s of credit (link)

Secured debt refers to the lender’s ability to seize an asset on default. Default refers to a breach in the agreement on part of the borrower (or, rarely, the lender). Most common reasons of default are not paying back a debt according to the agreement, such as missing payment or paying less than the amount due. For unsecured debt, there is a much more murky avenue for banks to retrieve their money, often through small courts. Secured debt, on the other hand, allows the lender broader protections in repossessing homes (foreclosure) or repossession (for auto finance).

Why Would I Want Secured Debt?

A lender managing his risk often means savings that is passed on to the consumer. If a lender has the assurance that if you don’t pay that he can take the house, he is able to offer debt at a much lower rate. This basic principle is what underlies the 30-year mortgage. Credit card debt is unsecured: it has the highest interest rate. Mortgage debt is often the most secure.

4 column font with interest rates as of January 2016 by Auto finance, student loans, mortgage and credit card

Banks are betting on the ease of collecting on defaulted loans. The order to which a consumer who is strapped for cash will prioritize his savings matter. Often it goes:

  1. Auto
  2. Mortgage
  3. Personal Loan
  4. Payday Loans
  5. Credit Card

All of this is after wage garnishments (for example, a tax lien or a child support payment) which are mandated by law. Many are surprised that consumers pay their car before their mortgage, which is what was shown in the previous recession. The reason is that mortgage collection is a much longer, arduous legal process for the lenders (rife with errors and horrific consumer stories and experiences). Also, you can sleep in your car but you can’t drive your house to work. Might be an argument to own an RV if I’ve ever heard one.

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What Other Nuances Are There?

Student loans are technically unsecured debts, considering you are unable to repossess a degree, education or knowledge. This is one of the reasons that student debt is not dischargable in bankruptcy (and lawyers/doctors declaring bankruptcy right at the end of law school/med school timing its removal from their report with their spike in income). Lenders would not consider offering such low rates to unproven students if they were able to discharge easily in bankruptcy.

Some of the major nuances to the distinction between unsecured and secured lending occurs in bankruptcy court. When a bankruptcy judge evaluates the case, he takes into account all of the consumer’s assets and debts. The details of who gets money first is very regional and depends on state law, lender practice and judge’s discretion. A general rule of thumb, however, is that unsecured debt does not have claims over a person’s assets.

In shorter terms, if you default on credit card debt, you are very very unlikely to have to give up your child’s crib.