What is an Unsecured Debt: Understanding the Basics
Oftentimes, when we take out a loan or undertake any debt we have to give the lender some sort of collateral. This gives them something to hold on to in case you aren’t able to pay up. In other cases, we are able to borrow money without that collateral, something we know as an unsecured bond.
Some people might have only heard of these debts which require individuals to pass certain criteria to be able to borrow money unsecured. It might surprise you to learn that a lot of things we take for granted are forms of unsecured loans, examples of which are credit cards, lines of credit, and most personal loans.
The Basics of Unsecured Loans
At its base, an unsecured loan means that the lender has no way to assure that they will get their money back. While this may tempt people to try to run with the borrowed money, the lenders, in this case, are able to claim the borrowed money through other means, most often involving claiming agencies or law firms.
To counter the risk they face with these loans, the lender will normally have a higher interest rate, including loans such as lines of credit and credit cards. This is what makes these products profitable for the lender and convenient for the borrower.
Unsecured Loans Compared to Secured Loans
Generally, most people are more aware of secured loans due to the significance of their utility, specifically car loans and mortgages. In either case, borrowers are at risk of losing what had secured them the loan.
The terminology may differ— for loans for large equipment similar to a car, what happens when the borrower is unable to pay is called a repossession, where the collateral is lost to the lender as part of the deal. Mortgages are similar but apply to homes, where the result is a foreclosure.
Once there is a failure to pay, the lender will begin to process the legal documents which let them claim the collateral. It should be noted that the value of the loan is normally tied to that of the collateral. Larger debts like those for cars and houses might also be restricted to a portion of the total value of the car or property.
Case Analysis
A good example of how important a loan can be is the incident caused by the 2006 housing market crash. This crash brought about a chain reaction by flooding the market with homes and causing the value of property to plummet.
This led to debt for many people, many of them homeowners who had invested heavily into their homes. As the value plummeted the homeowners lost their investment, leading to foreclosures on homeowners’ properties.
Once the bank had reclaimed the properties though, they also found themselves with assets with little value. This chain reaction happened even under the security of secured loans. The result of that event led to banks adopting a more conservative approach with their lending.
Final Thoughts on Unsecured Debt
What’s important, at the end of the day, is to do your research before undertaking any debt. Take your time when making the decision and try to figure out all the little details. After all, with the global economy the way that it is, it’s important to make sure you’ve got your finances planned out.
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