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In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. That differs from secured debt such as a mortgage, which is backed by a piece of real estate.
In the event of the bankruptcy of the borrower, the unsecured creditors have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors. The unsecured creditors usually realize a smaller proportion of their claims than the secured creditors.
In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and, in some jurisdictions, required) to set off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.
Under risk-based pricing, creditors tend to demand extremely-high interest rates as a condition of extending unsecured debt. The maximum loss on a properly-collateralized loan is the difference between the fair market value of the collateral and the outstanding debt. Thus, in the context of secured lending, the use of collateral reduces the size of the "bet" taken by the creditor on the debtor's creditworthiness. Without collateral, the creditor stands to lose the entire sum outstanding at the point of default and must boost the interest rate to price in that risk. If high interest rates are considered usurious, unsecured loans would otherwise not be made at all.
Unsecured loans are often sought out if additional capital is required although existing (but not necessarily all) assets have been pledged to secure prior debt. Secured lenders more often than not include language in the loan agreement that prevents debtor from assuming additional secured loans or pledging any assets to a creditor.
Examples of Unsecured Debt
Types of unsecured debt include:
- Corporate Unsecured Debt - Since this type of debt assumes a greater amount of risk, corporations that have lower bond ratings (such as BBB) are classified as unsecured debt due to their higher default risk.
- Consumer Lending - Also referred to as consumer financing. In the e-commerce retail sector, a growing number of merchants have embraced point-of-sale financing.
- Student Loans - This common type of debt is considered unsecured because it is difficult for private lenders and creditors to directly repossess assets if the borrower is unable to repay.
Failure to make a payment on an unsecured debt may ultimately result in reporting the delinquent debt to a credit reporting agency or legal action. However, a nongovernmental unsecured creditor cannot seize any of your assets without a court judgment in the U.S.
A creditor must file a complaint in state or federal court before a judgment can be made for or against the borrower.
In Malaysia, there are personal loans for the private sector and for the government sector. The personal loan interest rate for the private sector is always higher than the government sector because it is of lower risk for the bank to lend to the government sector. The government will pay the salary of the civil servants through a payroll system known as the Biro Angkasa and the bank will deduct the monthly installment of the loan from the civil servant's salary through this system, before the salary is even released. An example of these loans are cooperative loans.
Interest rates for personal loans in Malaysia are influenced by either one of these factors: loan amount, loan tenure and income of the applicant. In some cases, the bank will take 2 or even 3 of these factors to decide on the appropriate interest rate to be applied to the personal loan. In 2013, the Malaysian Central Bank introduces a new maximum loan tenure of 10 years for personal loan (previous maximum loan tenure was 25 years).
In India, there have several types of Personal Loans from Government Banks, Private Banks and NBFCs. Mostly Private Sector Banks and NBFCs providing high rate of Interest than Government Banks. Every Banks Provides Personal Loan on the basis of .
- High-yield debt
- Guarantor loan
- Medical debt
- Merchant cash advance
- Peer-to-peer lending
- Term deposit
- Credit card debt
- Personal loans
- Staff, Investopedia (2005-11-03). "Unsecured Debt". Investopedia. Retrieved 2018-07-26.
- "Measures to Further Promote a Sound and Sustainable Household Sector". BNM.gov.my.