What Does
Unsecured Debt Mean?
Unsecured debt is defined as the borrowing of money, as well as bills payable, that are not directly backed or guaranteed through a pledge of any asset as collateral. In the eventuality of a default on this debt, the creditor cannot recover the loan and the only option is to try renegotiating or involving a debt collection agency.
Unsecured debt is an important part of the economy, as it boosts the business and profits of the lenders.
Different classification of unsecured debt and secured debt is essential because legal implications and repayment priorities are different for unsecured loans compared to a secured category of loans.
In the case of bankruptcy of the borrower, the unsecured debts are paid last, and only if there are funds remaining. Hence, the interest rates on unsecured debt are much higher than those on secured debt.
Divestopedia Explains Unsecured Debt
Collateral could be assets in the form of:
- Shares
- Bonds
- Land and/or buildings,
- Vehicles or machinery
In the case of default in a repayment, the creditor can auction the collateral in order to recover the debt with interest. In the case of an unsecured debt, in case of a default, the creditor can come to certain settlement with the borrower for part payment or recruit a debt collection agency. In both cases, at best, only a portion of the debt is likely to be recovered. The option of going to court, if excercised, could work out uneconomically for both the borrower and the lender, in view of the expenses and time involved.