Debts are generally categorized as secured or unsecured, meaning they may or may not be attached to some form of collateral. Some examples of secured debts include mortgage loans, car loans and certain personal loans. Unsecured debts don't require you to pledge property, cash or other valuables as a condition of obtaining a loan or other form of credit. This means you're not at risk of losing your property should you default on the debt.
Credit cards are one of the most commonly used types of unsecured debt. Credit cards, including department store cards, are typically referred to as revolving credit accounts, since your available credit fluctuates as you pay your balance down. Generally, credit card companies look at your credit score and your household income when determining whether to approve applications for new credit. Your credit limit and interest rate are typically based on your credit score. For the most part, unsecured credit cards tend to have lower interest rates than secured credit cards, which require a cash deposit as a condition of approval.
Medical debts are also classified as unsecured since no collateral is required prior to seeking medical treatment. This includes debts owed to hospitals, health care clinics and private physicians. When you seek medical care you're typically required to complete paperwork identifying the party responsible for payment. This means that if your insurance doesn't cover the total bill or you're uninsured, you're agreeing to pay the amount owed for services rendered. Parents are required to act as guarantor when seeking medical care for children, and in some states, spouses can be held legally responsible for medical debts incurred by their husband or wife.
In addition to offering home and auto loans, many banks and credit unions also extend unsecured personal loans to customers. The requirements to qualify for a personal loan vary depending on the bank, but generally, you'll need to have a good credit score and adequate income to cover the loan payments. The kind of interest rate you'll get with a personal loan is usually based on your credit, but rates tend to be higher than those associated with a secured loan because there is more risk to the lender.
Student loans are also unsecured debt, but they are in a special category because the borrower typically cannot get out of them by filing for bankruptcy protection. This means less risk to the lender and because of that, along with the fact that they are often guaranteed by the government, they tend to carry lower interest rates than other unsecured debt. The interest on student loans is tax deductible up to a certain income threshold, which reduces the cost of these loans even further.
If You Default
When an unsecured debt goes unpaid, the lender can't immediately seize any property, but they do have other avenues for recovering what's owed. Unsecured debts are frequently turned over to debt collection agencies, who may choose to sue you to get you to pay. If you're sued in small claims court and a judgment is entered against you, the collection agency or credit can then take steps to garnish your wages or levy your bank account to collect their money. In addition to potential legal consequences, defaulting on an unsecured debt also hurts your credit. This can make it more difficult to get approved for new loans or lines of credit in the future.
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