Secured and Unsecured Debt

Secured debt is when credit is secured by collateral. In the event of default, the collateral can be seized, and then sold to pay the debt. In the event that the collateral does not fully cover the cost of the debt, creditors may file a deficiency judgment. A deficiency judgment allows the creditor to recover the difference (Cheeseman, H., 2007, p. 392). An example of secured debt is using one property as collateral for the purchase of another property.

Secured debt reduces the risks associated with lending. Another element of securing debt that should be understood is that if a person is going to take on debt that there is a possibility they may not be able to repay, securing the debt with specific collateral insures that other assets may be protected in the event of default (Superpages.com, 2007).

Unsecured debt requires no collateral to protect the payment of a debt. The only reliability for the creditor is the debtor’s promise of re-payment. In the event of default, the creditor’s only recourse is legal action and obtaining a judgment against the debtor. In the event that a debtor is judgment proof or has no income or property that can be garnished, the creditor may never collect on the debt (Cheeseman, H., 2007, p. 391). An example of unsecured debt is a credit card. Credit card companies have no guarantee that debtors will repay the debt. Unsecured debt is a higher risk for the lender and often times, higher return rates are involved, which make unsecured loans more expensive for the borrower (Investopedia.com, 2007).

Unlike secured debt, when this type of debt has been defaulted, all of the borrower’s assets are fair game for the lender to attempt to place judgment against (Superpages.com, 2007). Unfortunately, unsecured debt is harder to collect upon and often times it is turned over to a collection agency. If, after compromise and repayment negotiations produce no repayment results, the only recourse a creditor has is to file suit against the debtor. If the courts find in favor of the creditor, a judgment is entered. Once the judgment is entered, a creditor can then seize the assets of the debtor. In most states, the following are exempt from being executed against:

ERISA governed pension plans
Most clothing
Home furnishing which are not valuable
Some equity in an automobile
Some equity in a home (this amount varies largely from state to state)

When a debtor is owed money by a third party, such as an employer or bank, the third party who is paying the debtor can be forced to pay the creditor in place of paying the debtor. This process is called garnishment and levy. In some states, wage attachment is not permitted, in others, only a certain percentage of wages may be attached (Lawyers.com, 2007).

Resources

Cheeseman, H. (2007). Business Law. Sixth Edition. Pearson Prentice Hall: Upper
Saddle River, NJ

Investopedia.com. (2007). Retrieved on June 17, 2007 from:
http://www.investopedia.com/

Lawyers.com. (2007). Creditors legal rights. Retrieved on June 17, 2007
from:http://debtor-creditor.lawyers.com/creditors-rights/Creditors-Legal-Rights.html

Superpages.com. (2007). What is Unsecured Debt and Secured Debt? Retrieved on
June 17, 2007 from:
http://www.superpages.com/supertips/secured-and-unsecured-debt.html