What is unsecured debt?

In these uncertain times, risks are inevitable. We are now under more pressure from outside forces to make ends meet by whatever means necessary. This in turn, makes risk taking more frequent. In the past, we may have had more secure options for loans to cover expenses, but tough economic times have made this more a luxury than the norm. Because you may be turning to more unsecure debt, it is important to know the ends and outs of unsecured debt before using it.

Unsecured debt refers to a loan that is not secured by collateral. An example of unsecured debt would therefore be credit card debt1. By contrast, secured debt is secured by an underlying asset or collateral2. A mortgage for example, would be an instance of secured debt3. This is a good example of secured debt because the bank only loans out money that is backed by an asset, a house4. In this case, the lender has security in loaning their money because of the value provided by the underlying asset. It is for this reason that unsecured loans are more risky and expensive for lenders to take on. Unsecured debt is much more expensive is because the risk leads to higher interest rates5.

So what can you do to avoid using more costly, unsecured debt? Refer to the strategies below to start breaking the cycle.

  • Use cash only. Cash is tangible and real, so learn to train your spending habits to only reflect how much cash you have in hand. The less you rely in credit cards or unsecured debt the better, because as mentioned earlier it is actually more expensive to turn to these options.
  • Overestimate how much you think you are going spend. If you think you are going spend $100, plan to have $150 available to spend. Have a best case scenario number, and a worst case scenario number. The worst case scenario should be your absolute your limit, but it shouldn’t break the bank. Therefore, when you spend less than your absolute limit you can feel like you shot for a number well within your means. You may even end up spending far less that your initial amount. Just be sure to have a range, and work hard to stray within it.

Source: (Citations 1-5) http://www.investopedia.com/terms/u/unsecureddebt.asp

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