An unsecured debt is a loan that is not secured by secured by an underlying asset. In the case of a bankruptcy or liquidation this refers to any type of loan which is not collateralized by a lien on assets of the borrower. It can be described as the opposite of secured debt.
To explain unsecured debt it can be easily understood when a loan is taken to buy an asset. This loan is secured by the asset which stands as a security against the money lent. If the borrower defaults the loan amount can be recovered by selling off the asset that is known as the collateral security. The banks and financial institutions usually loan out money for buying assets like land, buildings and other valuables. When a consumer borrows money without the backing of such asset or collateral security it is not secured and is therefore categorized as unsecured debt. Examples of unsecured debt are personal loans, credit card loans and educational loans. The unsecured loans are expensive as they are not backed by any security. The risk of lending money is much higher and therefore they carry higher interest rates.
In the case of a borrower becoming bankrupt, the borrower’s specific assets pledged against the loan will be assigned to the secured creditors and if the value of assets exceeds the amount owed to the secured creditors can be claimed by the unsecured creditors. This means the unsecured creditors stand to recover only a small portion of their claims. If the debt is not tied to any property or asset, then the creditor has no right to seize the assets to recover the loan if the borrower defaults. The creditor can seek remedy only through legal process and get a court order. When the unsecured creditors are indebted to the insolvent borrower, he can set off his debts against the total amount owed to him as per some legal systems.
When people are burdened with too many debts by means of credit cards, mortgage, personal loans etc. they find it extremely difficult to cope with the different interest payments and the repayments. This is further complicated by penal interests levied when there is a default. There is also the lingering stress of increase in interest rates. To escape the situation financial advisors recommend consolidation of loans. By consolidation all the loans are combined into one single loan after negotiations with the various lenders and the debtor has to make repayment to only one loan which is easy and convenient.
The debt consolidation loan is typically an unsecured loan and there is no need for collateral security. The lender of this unsecured consolidation loan takes up more risk as the loan is not backed by any security. The lender compensates this higher risk by charging much higher interest rate that may be even five times the interest of a secured loan. Their one time fees and penalty may also be far too high. The unsecured debt consolidations are fast to obtain and therefore preferred by most people who are in need of immediate cash to tide over their financial crisis. To sum up unsecured loans are expensive but they help the borrower to overcome financial difficulties in time.