Part of your journey to personal financial success is knowing the difference between unsecured and secured debt, the difference between these two debts and when they’re applicable. With this understanding comes better personal financial decisions and a more secure future.

What is unsecured debt?

Unsecured debt is a common form of debt that has no collateral or security backing it. This means that if you default on those debt payments, then the lender has no asset to seize to recoup any outstanding money.

As unsecured debt is seen as risker by lenders, borrowers are subject to higher interest rates on these loans because of the lack of collateral. Forms of unsecured debt include credit cards, revolving credit facilities and personal loans.

There may be times when you need more money than you have in your emergency kitty, like an unexpected medical bill if you don’t have private health cover or needing to replace large appliances because the motor blew out.

A credit card or quick personal loan will give you the funds you need without delay. Personal loans and credit cards are both examples of unsecured debt — if you stop paying your credit card bill, there’s no property that you agreed the credit card issuer could seize in that instance.

Other forms of unsecured debt can include ‘buy now, pay later’ and interest free store cards, facilities which can easily have a negative impact on your home loan borrowing capacity, meaning you may not be able to borrow as much as you need or want.

Check how your home loan compares

What is secured debt?

Secured debt is debt that is backed by an asset, like your home or car loan. Should you default on the repayment of the loan, the lender can commence repossession of the collateral as part of their debt collection process.

When lenders have an asset to lend against, the risk associated with that loan is deemed low and borrowers benefit from lower interest rates because even if you stop making payments, the lender can seize the property, sell it in an attempt to minimise its losses.

Lenders also offer longer terms with secured debt because the loan is secured by the collateral and with less risk to the bank. Borrowers can get up to 7 years term for a secured car loan and up to 30-year loan for property related loan.

Which type of debt should you prioritise paying off first?

When it comes to paying off debt, a good rule of thumb is to prioritise paying off debt with the highest interest rate first. Look at unsecured debt versus secured debt and start with the loans with the highest interest rate and the shortest term and pay that off first.

There is the added benefit of a lower credit utilization ratio, which will help your credit score to increase that much faster. This is known as the snowball effect; as you pay off debts with high interest rates, there becomes more room in your budget to pay off the lower-interest debts faster.

Tell us: Enjoyed this article? Tell us what other property related topics we should share blogs on.

And while you’re here, take our mortgage shredder challenge and discover how much you can save on your home and investment loans by using loansHub technology as your personal mortgage manager. To get a discover why loansHub and what we do, click here.

This article does not constitute advice; readers should seek independent and personalised counsel from a trusted adviser that specialises in property, a tax accountant and property design specialist.