White Paper: What You Need To Know About Secured Debt & Unsecured Debt


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Different types of debt carry different consequences while they are active and in the event of a default. Whether people are struggling to make payments or have a surplus of cash they'd like to use to pay off their debts faster, it's important that they know how their debt can affect them. The best place to start is by understanding the two major forms of debt: secured debt and unsecured debt. This white paper will explain what each form of debt is, the consequences of defaulting, how each type of debt can affect your credit score, which to prioritize and under what circumstances, and finally tips to reduce and eliminate debt. If you have more questions about the different types of debt and how to handle them, contact a representative at Advantage CCS. (Source: http://www.advantageccs.org/secured-debt-and-unsecured-debt.html)

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White Paper: What You Need To Know About Secured Debt & Unsecured Debt

  1. 1. July 2013 2 What You Need To Know about Secured Debt & Unsecured Debt There are two major types of debt: secured debt and unsecured debt. Each type is incurred in different ways and bears different consequences should you default. Understanding the characteristics of each can help you prioritize your debt so you can better calculate how to pay down your bills smarter. Secured Debt: Voluntary, Involuntary & Defaulting Simply put, secured debt (or lien) is money you owe backed by collateral that the lending institution or creditor can collect on if you default. Home mortgages are an example of secured debt because if the borrower defaults on payments, the bank has the right to seize the home. The bank would then sell the property to recover the remaining amount of debt. A home mortgage is also an example of voluntary secured debt. Individuals can voluntarily take out loans against other types of property as well, such as: • Vehicles • Furniture • Equipment • Inventory • Investments (e.g., shares of stock) Secured debt is involuntary when you are required by law to make payments against your property. Payments may be imposed by federal law, state law, or even court order. These include: • Real property taxes • Income taxes (after delinquency) • Court judgments (if wage garnishment or repossession is granted) If a borrower defaults, or fails to pay back secured debt, the creditor must “perfect the interest” by filing a legal claim on the property in question with the appropriate agency. This is also called placing a lien on the property. A lien can prevent you from selling the property or transferring the title to another person. It also notifies other creditors that the filing creditor has the rights to the property. This is especially important for creditors in cases where multiple lines of credit are taken out against the same property (think home mortgages and equity lines of credit) or when filing for Chapter 7 or Chapter 13 bankruptcy. However, creditors can collect on secured debt usually without going to court if you default on your loans and haven’t filed for bankruptcy. Direct repossession (especially of cars parked on the street) and foreclosure are both possible without a court order in many states as long as creditors do not trespass on private property or disturb the peace. Court action is also an option for creditors to recover the full obligation. Unsecured Debt: Types of Debt & Defaulting The opposite of secured debt, unsecured debt is an obligation not backed by collateral. This is regarded as a much more risky venture for creditors, so they expect more of a return. This usually results in higher interest rates. Most debt is unsecured debt, including: • Credit card debt • Utilities bills • Medical bills • Student and personal loans • Income taxes (before delinquency) • Court judgments (if wage garnishment or repossession is not ordered)
  2. 2. July 20133 If an individual fails to make a payment or defaults on unsecured debt, creditors can contact you to ask you for the payment, report the event to credit bureaus, and file a lawsuit against you. However, nongovernmental unsecured creditors are not allowed to seize any of your assets without a court order. After obtaining a court order, creditors may be able to investigate your income, other debts, and assets; garnish your wages and savings; and seize and sell real and/or personal property. The percentage of your wages creditors are allowed to garnish varies from state to state, and certain laws also protect some of your personal assets from seizure (e.g., primary residence, pension plan, and home furniture). How Secured & Unsecured Debt Affect Credit Score For both secured and unsecured debt, late payments are reported to credit bureaus and will have a penalty (a loss of 60-110 points for a single 30-day late payment). Defaulting on either form of debt is also reported to the credit bureaus. For unsecured debt, if payments are delinquent for over 150 days, the account will be marked “charged off” on your credit report and remain there for 7 years. This means the lender could not recover the debt and wrote the amount off as a loss. However, the debt is still active, and creditors can still collect on it through court action for 3-10 years depending on the state you live in. For secured debt, property seizures are also reported to credit bureaus. Homes will appear on a credit report as foreclosures and other items, including cars, will appear as repossessions. Charge- offs, foreclosures, and repossessions can all seriously impact your credit score. Your credit score may drop 80-160 points for each offense depending on other factors of your credit score, and the defaulted status will remain on your credit report for 7 years from the date of the first missed payment. creditors can collect on secured debt usually without going to court if you default on your loans & haven’t filed for bankruptcy.
  3. 3. July 2013 4 Which Debt to Pay off First? If you find yourself in a position where you are choosing which payments to make, secured debts are generally the better choice. These payments are usually harder to catch up on, and you stand to lose a real asset (e.g., shelter, personal transportation, etc.). This hard loss also hits your credit score exceptionally hard. On the other hand, if you are making extra payments to get out of debt faster, unsecured debts are usually the way to go. They often carry higher interest rates than secured debts, so the faster you pay them down, the more money you ultimately save in the process. However, it’s important to remember that even when you are focusing on one debt to pay off first, you still need to pay at least the minimum amount on all your loans and lines of credit. Tips to Reduce Unsecured Debt The best way to approach unsecured debt is to live within your means and spend less than you earn. However, if you are already in a situation where you are struggling to meet your monthly obligations, there are still a few options for you. AssessmentandBudgeting.Firstit’simportanttounderstandwhatyourfinancialposition is. Take an inventory of all the income you have and what you spend every month. Write down rent/mortgage payments, utilities bills, food, student loan payments, credit card bills, medical or insurance bills, savings, other commitments, and how you spend the remainder of your money (clothes, cosmetics, coffee, etc.). If you are spending more than you’re taking in, you’ll have to make cuts somewhere, and this list will help you see where you can scale back. Debt counselors can also work with you to find more tailored ways of curbing your spending to get out of debt faster. Debt Consolidation. If high interest rates on unsecured debt are creating problems, debt consolidation may be able to help. This method combines multiple loans into a single loan, usually lowering your interest rate in the process. Rather than lowering your premium, debt consolidation aims to lower your monthly payments so that the debt is more manageable. Debt Settlement. A risky option, debt settlement firms attempt to lower the principle of your unsecured debt by negotiating with creditors to reduce the amount. This process requires clients to stop paying all bills from the debt in question for several months, damaging your credit score. Clients will instead make payments into an escrow account held by the debt settlement firm. When the account reaches a certain amount of money, settlement negotiators will approach creditors to offer the cash available on hand in exchange for dismissing the rest of the balance. Creditors are not obliged to consent, and if they do, the amount dismissed will be taxed at your income tax rate. Debt Management Plan. Those with severe debt may qualify for debt management plans through reputable consumer credit counselors. Your credit counselor will work with your creditors to lower interest rates and even waive late fees so that you will have a lower monthly payment. This also allows you to pay down the principle faster. Instead of submitting payments to your creditors, you will send a lump sum to your credit counselor, who then arranges the payments. For those paying back multiple creditors, this helps keep all the accounts organized. Debt Management Plans last 3-5 years, enough time for borrowers to pay off their unsecured debt. Advantage CCS is a consumer credit counseling firm committed to offering affordable help to those who need assistance managing their finances. For more articles on debt management and tips on taking care of your budget, check out our blog. If you have more questions about your finances, contact a representative at Advantage CCS today.