Unsecured debt is when money is loaned to a borrower without the lender requiring a lien against an asset for collateral. A good example of an unsecured debt would be a credit card or payday loan. There is a greater risk of loan default on unsecured debt, therefore lenders and banks are growing more cautious when issuing an unsecured line of credit. Because of this, interest rates and fees are much higher than a secured loan, such as a car or home loan.
Types
The most common type of unsecured debt is a credit card. Credit cards can be applied for over the phone, online or in person. Some credit cards only require a name and Social Security number while others require an extensive application process that can take days to complete. Once approved, credit card holders are issued an interest rate based on their credit score. The company makes money off of the interest rate which can sometimes be as high as 35 percent. High risk borrowers or those with a low credit score may have to pay a yearly fee for services. Payday loans are gaining popularity and in most states lend up to $600 at a time. Payday loans lend to anyone with a checking account regardless of credit history. Utility bills are also another form of unsecured debt. Cell phones, Internet, cable, electricity, gas and fuel accounts can generally be set up without a security deposit or collateral upfront.
Advantages
The advantages to unsecured debt is that it generally provides quick access to cash and services. Unsecured debt allows the borrower to have access to cash that doesn't have to come immediately from a paycheck or bank account. It allows a grace period to pay back the cash while freeing up other liquid assets.
Disadvantages
Unsecured debt can be abused at times. Some people may acquire too much debt and are financially unable to pay it back on time. This can lead to credit card debt which contains high interest rates, fees and leads to low credit scores. Failure to use unsecured debt for emergency purposes or to build and establish credit can lead to overspending and living above your household budget.
Qualifications
In order to qualify for unsecured debt, a borrower must have a good credit score. A credit score is a combination of information obtained from someone's credit report. Most credit reports contain information from the three major credit bureaus, TransUnion, Equifax and Experian. According to the MyFico website, a good credit score is between 700 and 800. Anything over 800 is considered excellent credit. Anything under 700 is considered below average credit and each application will have to be reviewed before approval.
Penalties for Non-Payment
Late payments on an unsecured loan, such as a credit card, can lead to a lowering of a credit score. This is because most credit card companies report late payments to the major credit bureaus. This can affect a borrower's ability to obtain future credit. If someone defaults or stops making payments on an unsecured debt, such as a credit card, utility bill or payday loan, he can face the original debtor seeking a judgment against him to collect the amount owed.
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