When a debtor fails to pay, a creditor’s ability to recover the money may depend in part on whether the debt is secured or unsecured. Although both types of debt create an obligation to repay, a secured creditor generally has additional protection if the debtor defaults.
Understanding the difference between secured and unsecured debt is essential for evaluating credit risk, responding to a default and determining what collection remedies may be available.
Protecting your interests
A secured debt is backed by collateral. The debtor gives the creditor rights to a specific property if the debtor fails to meet the terms of the agreement.
Unsecured debt isn’t backed by a specific piece of property serving as collateral, such as credit card balances, unpaid invoices and some personal loans. The creditor can still pursue legal remedies when a debtor fails to pay. However, they don’t have rights to a particular asset that can be recovered or sold to satisfy the debt.
The distinction between secured and unsecured becomes particularly important when a debtor defaults. A secured creditor may have rights against the collateral in addition to other remedies outlined in the loan agreement. An unsecured creditor usually has to compete with other creditors for whatever assets are available to satisfy the debtor’s obligations.
Bankruptcy can make the distinction between secured and unsecured debt even more significant. The bankruptcy process can affect both types of claims, but secured creditors may have rights that unsecured creditors do not.
In addition to secured and unsecured creditors’ claims, bankruptcy can also raise questions about liens, collateral value and exemptions. The best way for creditors to protect their interests is to consider collection risk before extending credit. Even so, the unexpected can happen, and a debt considered a good risk can become delinquent.
If a debtor has stopped paying, waiting too long to evaluate your options can make collection more difficult. A legal professional can review the loan agreement, determine what rights and remedies may be available and help develop a strategy for recovering debt.