One key feature about all mortgages homebuyers should understand is the fact that these loans are secured. That means your property is used as collateral, so in case you cannot repay the loan, your lender can avoid significant losses by selling your home. Learning the difference between secured and unsecured debt is important. Let’s take a look at what constitutes secured debt versus unsecured debt, how this affects your mortgage, and what happens when you can’t make your payments.
What Is a Mortgage?
Mortgage is a secured loan that homebuyers use to purchase property or borrow money against property. You must meet certain criteria to be approved for a mortgage, such as having sufficient income and credit history. You can get a mortgage with varying term lengths and either fixed or variable APR. The most common type of mortgage in the U.S. is a 30-year, fixed-rate mortgage. Once you’ve bought your home, your mortgage will be listed as a lien on the title. This means that your lender can take your property if you fail to make payments. They can sell the property through foreclosure to help them avoid losses.
Secured Debt vs. Unsecured Debt
A mortgage is a type of secured loan. This means that the lender has a security interest in the property and your house is being used as collateral to secure the debt. A security interest occurs when a borrower agrees that a lender may take collateral owned by the borrower if they should default on the loan. In contrast, unsecured loans are loans that do not use collateral, like credit cards, student loans, or personal loans. For example, a car is used as collateral for an auto loan. So, if you don’t pay a car loan according to the terms, the lender could repossess your vehicle. Another common secured loan is a home equity loan, which, like a first mortgage, also uses your home as collateral, but for a loan you could use for other reasons besides buying a home.
Risk
Because unsecured debt isn’t connected to any type of collateral, it’s a riskier lending option for lenders. Unlike secured debt, lenders can’t automatically take your property if you default on an unsecured loan, so if you don’t pay back your loan, your lender would have to file a lawsuit against you for the payments or lose money.
Interest Rates
Interest rates for common types of unsecured debt, such as credit cards, medical bills, personal loans, and student loans are generally much higher than interest rates for secured loans like mortgages and auto loans. Interest rates on unsecured debt tend to be higher due to the increased risk the lender faces. Essentially, lenders increase the cost of borrowing to offset the risk of defaults. Other factors play a role in the interest rates of your mortgage, including broader interest rate trends, your credit history, and your debt-to-income ratio.
What Happens When You Can’t Pay Secured Debt?
You can face serious consequences when failing to pay secured debt like your mortgage. Once you stop making payments on your home mortgage, your loan will go into default. This means that you’ve broken the contract between you and your lender. In short, you haven’t upheld your end of the bargain. If you can’t resolve the issue with your lender, your lender can start the process of taking your assets to prevent their losses. In the case of mortgages, that means foreclosing on your home.
What Happens to Secured Debt in Chapter 7 Bankruptcy?
When you file Chapter 7 bankruptcy, your bank still has the right to take back and sell your property. However, even if they sell your home for less than what you owe, they aren’t able to sue you for the difference. This is called a deficiency judgement and you are protected against it during Chapter 7 bankruptcy.
What Happens to Secured Debt in Chapter 13 Bankruptcy?
Chapter 13 bankruptcy allows you to keep your property and simply reschedule your payments so that you repay all or some of your debt. This is also called a wage-earner’s plan. During this plan, you’ll be able to make payments over the course of three to five years.
