What is Unsecured Debt
Unsecured debt is a loan that is not backed by an underlying asset. Unsecured debt includes credit card debt, medical bills, utility bills and other types of loans or credit that were extended without a collateral requirement. This type of debt presents a high risk for lenders, also referred to as the creditor, since they may have to sue for repayment if the borrower doesn't repay the full amount owed.
BREAKING DOWN Unsecured Debt
Unsecured debt can be personal or business debt. As a result of the high risk to the lender, unsecured debt tends to come with high interest rates, which increases the financial burden on the borrower. Borrowers can wipe out unsecured debt by declaring bankruptcy, but taking this dramatic step makes it more difficult to obtain a future unsecured loan.
Secured Debt Vs. Unsecured Debt
Unlike unsecured debt, secured debt is backed by an asset, such as real estate or a vehicle, also known as collateral. Under the terms of a secured loan, the lender is allowed to seize the collateral used to guarantee the loan if the borrower defaults. Examples of secured debt include mortgages, which are secured by real estate, and title loans, which are secured by vehicles. Since the borrower has more to lose by defaulting on a secured loan and the lender has something to gain, this type of debt is less risky for the lender, and therefore comes with lower interest rates when compared to unsecured debt.
Collecting Unsecured Debt
If a person fails to make payments on unsecured debt, the creditor first contacts him to try and receive payment. If the borrower and the creditor cannot reach a repayment agreement, the creditor's options include reporting the delinquent debt to a credit reporting agency, selling the debt to a collection agency and filing a lawsuit. If the creditor files a lawsuit in state or federal court, a court ruling may force the borrower to use specific assets to repay the unsecured debt.
Corporate Unsecured Debt
Since unsecured debt is risky, in addition to higher interest payments, bond rating agencies usually give the debt a low rating. For example, on June 20, 2016, Kroll Bond Rating Agency (KBRA) assigned a senior unsecured debt rating of BBB+ to a bond issued by Sioux Falls, South Dakota-based Meta Financial Group. The highest rating that the financial group could have received was a AAA rating. A junk bond rating is BB.
Since the debt was not backed by an asset, the BBB rating was based on Meta Financial Group's robust liquidity profile, strong asset quality metrics and positive risk-weighted capital ratios. If the debt was secured, there is a high likelihood that the bond rating agency would have given a rating of A or higher.