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Secured and Unsecured Debt Explained

The law generally recognizes two types of debt, secured and unsecured.  Secured debt is backed by collateral, usually in the form of a house, car, boat, or other piece of valuable property.  Unsecured debt is backed only by a person’s promise to pay.  Credit card debt is a common example of unsecured debt.  The actions that can be taken against a borrower to fulfill the terms of a secured or unsecured loan will differ depending on the type of debt that the borrower holds. 

When a person fails to pay their debts, the lender is often well within their rights to initiate legal action against the borrower in an effort to get their money back.  If the case makes it to trial and the borrower is forced to pay the debt, one of two things will happen:

If the debt is secured, that is backed by a piece of property; the judge may order the collateral that was initially used to secure the loan be forfeited to the lender so they may recoup some of their losses.  If the value of the collateral has depreciated over time, the judge may decide to forgive the remainder of the debt or order an additional amount of money be paid to cover the difference.  If the value of the collateral has appreciated over time, the judge may order the lender to issue a refund to the borrower for any money that is remains after the collateral is sold and the debt is paid off. 

If a debt is unsecured, the judge will more likely than not order some type of payment plan to be established.  Since there is no legal obligation for the borrower to fork over their private property to pay off a debt, private property is not generally used to settle unsecured debts.

There are factors that will affect a judge’s decisions.  For example, some forms of bankruptcy would allow a person’s assets to be liquidated in order to settle certain debts.  The above mentioned examples illustrate how debts might be settled without a bankruptcy.

The likelihood that a person will be sued for the value of unsecured remains low if the value of the debt is low.  In order for a lender to sue a borrower they will have to pay legal fees and certain costs in order to face the borrower in court.  In cases where an unsecured debt is relatively low, the lender will more often than not attempt to establish a payment plan for the borrower without the aid of a court.

Litigation is often only used against the most stubborn of borrowers and those who owe a substantial amount of money.  Some lenders may not want to risk losing a trial if they can communicate with the borrower directly to set up a payment plan that both parties can agree on.  Since lenders are in the business of making money, many will be hesitant to pursue a trial if they feel that they could lose more in legal fees than they stand to gain from a court decision.