Several types of lending are available when borrowing money, and one type of loan is an unsecured debt. Any debt that isn’t tied to an asset is unsecured—meaning that something valuable, like your car, home, or a savings account, cannot be used by a lender to recover their money if you are unable to repay it. Since unsecured debt offers no security for repayment, it’s considered riskier for lenders. It can be less stressful for borrowers, however, since they don’t stand to lose important assets.
Common forms of unsecured debt
Unsecured debt is common in many forms, including business loans, medical debt, apartment leases, and utility and cell phone bills. Three of the most widespread types are credit card debt, personal loans, and student loans.
Credit card debt
By far the most common form of unsecured debt, a credit card allows you to borrow money up to a predetermined limit. Credit cards offer a revolving line of credit, which means that any borrowed money is restored to your credit limit as you pay it back—like a revolving door. By paying your credit card balance in full each month, you’ll avoid paying interest charges; otherwise, you’ll pay interest and the balance will roll over into the next month’s billing. Not all credit cards are unsecured, but most do not require collateral. Instead, the loan offer and terms are based on your credit history and score, which are negatively impacted if you fail to make timely payments or default on the loan.
Unsecured personal loans are usually obtained through your bank or credit union. These are also sometimes referred to “signature loans”, because if you have a good credit history and an existing account with the financial institution, a signature is usually the only requirement to get one. The terms for a personal loan depend on your credit score, with a high score typically resulting in a lower interest rate. Personal loans also tend to have lower interest rates than credit cards, so they can be appealing if you qualify.
Another widespread form of unsecured debt, student loan debt totaled $1.68 trillion in the United States in 2020. There are two types of student loans—personal and federal—but most come with benefits for students, like lower interest rates and deferred payments until after graduation.
Benefits of unsecured debt
Unsecured loans may offer less security for lenders, but they do provide major benefits for borrowers who pay their debt on time:
- Safety of assets: The most noteworthy benefit of unsecured debt is that your loan isn’t tied to any collateral, meaning that your home, car, or savings aren’t at risk if you fail to repay your debt for any reason.
- Quick credit improvement: Unsecured debt typically has a shorter repayment term, making it possible to quickly improve your credit score with this type of loan.
Risks of unsecured debt
The disadvantages of unsecured debt may be minimal for those with a healthy credit score and history, but there is always a degree of risk involved when borrowing money. Potential drawbacks of unsecured loans include:
- Higher interest rates: If you have a good credit history, you can likely find an unsecured loan with a reasonable interest rate. Generally, though, unsecured debt has higher interest rates since the lender cannot rely on collateral if the loan is not repaid.
- Lower borrowing limits: Because an unsecured loan is considered riskier for the lender, borrowing limits are typically capped at a lower amount until you prove to be creditworthy.
- More difficult to obtain: Unsecured loans can be difficult to acquire with a subpar credit history, since there is less security involved for the lender.
- Credit damage: As with any loan, defaulting can negatively affect your credit score and make it difficult to borrow money in the future.
Resolving issues with unsecured debt
If your unsecured loan becomes unmanageable, talking to your lender should be your first step—Kredit can help you connect. Some options you should discuss together include:
- Credit counseling: This type of guidance often addresses debt management by creating a debt relief plan, which is personalized for your finances and is typically less drastic than other options.
- Debt consolidation: This involves combining multiple existing debts into a single new loan—typically with a lower interest rate. For credit card debt, this can mean consolidating your existing credit card payments into a new credit card that charges little to no interest for a certain time period, also called a balance transfer.
- Debt settlement: The goal of debt settlement is to negotiate a better payment plan or a reduced, lump-sum payment to settle your debt.
- Bankruptcy: Declaring bankruptcy is a legal process that can erase some or all of your debts if you qualify, though student loans are usually excluded. It can also come with negative side effects, including a ruined credit score that remains on your credit report for up to 10 years.
Unsecured debt has both advantages and disadvantages, making it important to carefully evaluate your borrowing options. Read more about secured debt to discover other types of loans that could be right for you.