What is unsecured debt?
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Updated: January 15, 2024
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With the rising cost of living, Canadians increasingly take on debt by relying on credit cards, personal loans, and other options to cover expenses. It's important to understand that not all debt sources are created equal. Debt comes in the form of both secured and unsecured. Is one better than the other? Unsecured debt might sound less desirable but that doesn't mean it actually is.
Before taking on unsecured debt of any kind, it's important to understand what it is, how it works and how it could impact your credit. In this article, we explain unsecured debt, the most common types Canadians take on, and whether it may be right for your situation.
What is unsecured debt in Canada?
Unsecured debt is a type of debt that does not have collateral attached to it. This means that there are no assets available to the lender to seize (i.e. a deposit or a home) should you default. Since the lender’s risk is higher, you’ll generally experience higher interest rates and decreased loan sizes than on secured loans.
What are the different types of unsecured debt?
Credit cards provide a convenient way to make purchases up to a specified limit. Any credit card debt must be paid within the month the debt was acquired. Any leftover balance from the previous month is subject to interest charges, adding to your balance and thus your repayment amount.
If you pay your balance in full every month, there is no charge for carrying credit debt. That said, easy access to credit can come at a cost, as credit cards typically charge 20%+ interest on unpaid balances. The high interest rates typically associated with credit cards emphasizes the need for responsible financial management by following the 20 golden rules of credit cards.
Student loans, offered by government and private lenders, are designed to assist students with educational expenses. They are different from other unsecured loans because payments generally kick in after a post-graduation window. This gives you time to get a job before you are required start paying back your student loan.
With student loan debt, missing payments for over 270 days puts you in default. In this case, your payments are sent to the CRA for collection. To prevent this scenario, review smart strategies for repaying student loans.
Personal loans offer a predictable way to borrow money from banks, online lenders, or financial institutions. You borrow a lump sum, which is repaid consistently throughout your loan term.
Personal loan interest rates tend to decrease with a lower payback period and higher credit score. Always shop around to find the best rate. You can start with the best personal loans in Canada.
Payday loans have astronomical borrowing costs and should only be used as a last resort. They are designed to provide a small, short-term relief while you await your next pay cheque.
Be extra cautious when pursuing a payday loan. In fact, it's wise to try to avoid them altogether, if at all possible. Lenders often have complex fees that can deceive unsuspecting borrowers into borrowing more than they can afford to pay back. Always inquire about the APR rather than the interest rate, as the former calculates the total cost of borrowing.
Cell phone and utility bills
Don’t forget to pay your bills! Unpaid balances for cell phone plans, electricity, gas, and water bills generally incur interest. While the interest rates may not be as high on these types of debts as other forms of unsecured debt, such as payday loans, failure to pay can result in service interruptions and collection efforts.
Entrepreneurs and small business owners use unsecured business loans to finance operations. These can have varying structures, such as a line of credit or lump sum loan. Furthermore, terms can range from a few months to several years.
In Canada, medical debt comes from non-public healthcare services, such as dentists, private procedures and rehabilitation. While less common than in the United States, some providers may offer payment plans with interest.
Pros and cons of unsecured loans
Faster funding since there is no need to value collateral assets
Lower administrative fees than secured loans, make them more appealing for smaller amounts
No risk of losing your collateral asset
Higher interest rates due to increased lender risk
Lenders are less likely to loan you large amounts
Missing payments damages your credit score, and lead to bankruptcy
More scrutiny on your income stability and credit score
Secured debt vs. unsecured debt: What’s the difference?
Unsecured debt is riskier to lenders because there is no collateral. As such, unsecured loans tend to have higher interest rates and lower loan amounts. Lenders are more cautious with unsecured loans, resulting in more scrutiny of your income stability and credit score.
However, the application process for unsecured loans is more streamlined as you won’t need to appraise any assets. This can result in lower administrative fees, somewhat offsetting the higher interest rates.
Unsecured debt relief options
Debt settlement involves using a third party to negotiate with creditors. Their goal is to negotiate a lower amount owed. However, this service can negatively impact credit scores, and they charge a fee.
Debt consolidation uses a larger loan to centralize multiple debts, such as credit cards or payday loans. The goal is to use a lower-interest-rate loan to pay off high-interest-rate debt. However, a secondary benefit is centralizing payments, making management and tracking easier.
When finding the best option for debt consolidation loans, assess interest rates, loan terms, and eligibility criteria. A comprehensive evaluation allows individuals to choose a consolidation plan that best suits their financial needs when comparing the top providers.
Debt management plan
Non-profit agencies often facilitate a debt management plan. It consolidates debts into a single monthly payment with potentially lower interest rates.
Debt forgiveness, though rare, involves lenders forgiving a portion of your loan. However, it can lead to tax implications and credit score impacts and. you're still on the hook to pay the remaining amount.
Bankruptcy is a legal process in Canada for those with overwhelming debt. It can eliminate most debts through bankruptcy filings. While it provides relief from debt, bankruptcy significantly affects credit scores and can have long-term financial repercussions.
A consumer proposal is more favourable than bankruptcy. It allows individuals to negotiate with creditors to repay a portion of their debts while protecting their assets. Consumer proposals can negatively impact your credit score.
Is unsecured debt good or bad?+
Unsecured debt is good if you need financing and don’t want to risk assets. However, it has higher interest rates than secured loans.
Which is better: secured or unsecured debt?+
Secured debt has better terms. The interest rates are lower, and you can borrow larger amounts. However, some borrowers are uncomfortable with collateralizing assets, making unsecured debt the better option.
Does unsecured debt hurt your credit score?+
Unsecured debt hurts your credit score if you fail to make payments. Furthermore, carrying high balances on credit cards can lower your credit score.
Are student loans considered unsecured debt?+
Yes, most student loans are unsecured because they are not backed by collateral. Government student debt is only forgiven through bankruptcy after +7 years of school.
Can you lose your home over unsecured debt?+
While you can't directly lose your home over unsecured debt, failing to make payments can result in legal proceedings. This can lead to bankruptcy and affect your ownership of your house, such as liens placed against it.