In the world of finance, you have two types of debt: secured and unsecured. Secured means that there is something being used as collateral, or security, to ensure that the loan is going be repaid. For instance, a home is collateral for a mortgage. Unsecured means no collateral is necessary for the loan.
Unsecured debt is far more difficult to acquire since there is no guarantee that the debt will be repaid. If the borrower filed bankruptcy, for example, the creditor could be out the money they lent them. Since it commands such an extremely high level of risk, many creditors will not participate in it.
The Cost Of Unsecured Debt
There are still institutions who will issue unsecured debt. However, due to the enormous risk that they are taking, they want to utilize every possible avenue to increase the likelihood that they will be paid. That's why unsecured debt is much more expensive than secured debt. The lender wants to make sure that in the event the borrower defaults, they have at least gotten some of their money back. The loan cost is based on the level of risk: the higher the risk, the more the loan will cost.
Who Benefits From Unsecured Debt
The main ones that benefit from obtaining unsecured debt are those individuals who do not have anything that they can use for collateral.
Young people who are just starting out have not had adequate time to establish themselves. Therefore, a lender has nothing to use as a frame of reference for their credit-worthiness. An unsecured loan could mean the difference in being able to get a loan without credit, and being denied.
Individuals fresh out of a bankruptcy or a foreclose will have acquired a massive hit to their credit. They will also have nothing that can be used for collateral. Unsecured debt takes away the burden of proof.
Benefits Of Unsecured Debt
- Unsecured debt take less time to apply for due to the decreased amount of paperwork and time involved in the process. This means a quicker turnaround time.
- If you do have some form of collateral, such as equity in your home, it will not be tied up in this loan. This leaves it available in the event that it is needed later on.