Mercy Maranga writes content on Finance and Debt Management. Visit her site here for more information on Finance and how to effectively Manage your debts. Debt
Unsecured debt refers to a loan that is not secured by underlying collateral. It refers to a type of debt that has no collateral and therefore no lien on any specific asset of the borrower if bankruptcy or liquidation.
Since there is no collateral, unsecured loan carries more risk for the lender. The high risk involved makes the loan more expensive. Any additional risk to the lender translates into higher interest rate to the borrower. The concept of unsecured debt is better understood when contrasted with it's opposite. The opposite is a secured debt.
A secured debt is created when a borrower pledges an asset or assets as collateral for a loan. The debt is therefore secured against the collateral unlike in the case of unsecured debt. If the borrower defaults, the lenders take possession of the asset that was used as collateral and may sell it to recover their money. Secured debt grants the creditor the bundle of rights to the specified asset.
The purpose of a secured debt is two fold. It relieves the creditor of most of the financial risks because it allows the creditor to seize the assets if the borrower defaults. A secured debt also affords the borrower favorable terms in the sense that the creditor may offer attractive interest rates as well as ample time for the borrower to service the loan. Although unsecured debt is expensive, it comes in handy when one has no asset to put up as collateral thus making those in employment but do not have assets have access to loans easily.
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