Unsecured vs. Secured Debts: What’s the Difference?
Loans generally fall into two different categories: unsecured debt and secured debt. What is the difference between the two, and what are the implications for the borrowers and lenders when it comes to non-payment?
Unsecured debts are those that are granted without being backed by any collateral. Since there are no assets that can be taken by the lender to offset the loan in the event of default, lenders can only acquire compensation by taking legal action. As a result of the higher risk to the lender, unsecured loans are made at greater cost, i.e. at higher interest rates. Credit scores and debt-to-income analysis are required for these loans to be granted. Credit cards are the most common examples of unsecured lending.
With a secured loan, the borrower puts up an asset as surety or collateral. Should the borrower then default on loan repayments, the lender can claim that asset as compensation for the loan. Mortgages and car loans are good examples of this. With a car loan, if the borrower doesn’t pay, the lender takes possession of the car. If a firm or business doesn’t pay its mortgage, the bank can repossess the building.
The primary difference between these two kinds of debt is the presence or absence of collateral. The risk of default on secured debts is lower because the borrower has so much more to lose. With unsecured debts, the lender accepts a greater risk, as collecting on them is much more difficult and costly.
Kore Capital Corporation is a business financing company that specializes in offering lines of credit, particularly through factoring, to firms in several different industries. For more information on unsecured and secured debts and their implications, as well as our various financial services, contact us.