Unsecured debt is debt without collateral to back the loan in case of default.
Debt that has no collateral to back the loan in case of default.
A defining characteristic of an unsecured debt is that it does not require collateral to secure the loan. (Collateral is an asset that the lender can take if the borrower defaults on the loan.) This means there is a higher risk of default for the lender, and that is why unsecured debt generally carries a higher interest rate than secured debt.
The most typical assets used as collateral are homes and cars. With a mortgage, home equity loan, home equity line of credit, or refinancing, the home is used to secure the debt. If the borrower defaults on the mortgage, the lender takes possession of the home through foreclosure. Similarly, the car is used as collateral for a car loan. Also, certain secured credit cards use money deposited by the borrower as collateral.
Interest rates reflect the risk to the lender. With a secured debt, there is less risk since the lender has a way to recoup some of the money it has lent out, and the borrower has so much to lose if s/he defaults. For example, the borrower can lose his/her home if the mortgage is not repaid, or the car can be taken if the car payments are not made. In addition to the damage that would be done to the credit scores, these are dire consequences. For this reason, secured debts are considered a better risk for the lender so the lender can afford to offer the borrower a lower interest rate. Because an unsecured debt does not require any collateral, the interest rates are much higher for this type of loan.
