Understanding the terms Secured and Unsecured debt

Secured loans

A secured loan is debt which is secured by property. Most common types of property taken as security is real estate, motor vehicles, boats, caravans etc,  however other assets can also be taken as security to back the loan. Security can also be referred to as “collateral”. Once you have provided an asset as collateral the lender will usually register its security and you will not be able to provide (or pledge) this asset as collateral for any other loan.

What this means is that if you fail to repay the loan (as agreed with the lender), the lender can repossess the security and sell it.  This type of action is commonly referred to as a “repossession” or a “foreclosure”.

There are many reasons why lenders insist on taking security for a loan.  The most common reason is that it protects the lender against the risk of default.  If the lender has taken good security then it reduces the risk of losing money in the event of default.  If the lender can reduce its risk of default it will usually offer a reduced rate of interest. The time period for secured loans tend to be longer given less risk is involved.

Unsecured loans

An unsecured loan refers to debt which is not secured against any property.  This means that if you fail to repay an unsecured loan the lender cannot repossess an asset in the event of you defaulting on the loan.  However, if you fail to pay an unsecured loan and you owe the lender more than $5,000 (current as at March 2012) then the lender could force you into bankruptcy by an order of the court.  This process is much more complicated and costly for a lender and as such lenders tend to charge higher interest rates to protect themselves against this additional risk. The time period for unsecured loans also tend to be shorter given the high risks involved.