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6 Debt Misconceptions: Secured vs. Unsecured Debt

Learn the truth about these two types of credit so you can make smarter choices about the credit you use.

Clearing up credit misconceptions like the ones discussed in the video helps you understand the credit that you use better. You can make smarter choices about new lines of credit that you open, as well as how you should manage your debt.

Misconception Number One: Secured credit is better because it’s “protected.” The truth? That protection is for the lender, not the borrower. Secured credit is credit that has collateral. This protection isn’t for the borrower; it’s for the financial institution in case you default.

Misconception Number Two: There is no difference in the risk between secured and unsecured. The truth: Secured credit carries a slightly higher risk because if you fail to pay, your collateral can be taken to recoup the losses. The company or financial institution holding the debt limits the risk of default with collateral.

Misconception Number Three: Property can be repossessed to pay a debt, even if it’s unsecured. The truth: If a debt is unsecured, property can only be taken with a court order. Sometimes borrowers get nervous when they haven’t made payments on an unsecured debt, because they think their possessions can be taken away or that the police will be called. Not true! If a debt is unsecured, the only way property can be taken is if a judge orders the liquidation in civil court. So don’t let debt collectors scare you. They cannot come and take your property. They have to sue you first.

Misconception Number Four: Secured credit only refers to special types of loans. The truth? Secured credit cards can be a good stepping stone to unsecured, as long as you can manage the debt. When you think about secured credit, your thoughts may be about home and auto loans, but it can also refer to secured credit cards. If you don’t qualify for an unsecured credit card because your credit score is low, secured credit cards can be a smart way to build credit.

Misconception Number Five: Credit lines can only be secured with tangible property. The truth: Tangible property doesn’t just refer to a possession, like a car or a home. It can also include cash that you put down as a deposit. Cash is the most common type of collateral used with secured credit cards.

Misconception Number Six: You’re 100% certain to lose all collateral attached to secured debts during bankruptcy. The truth: Certain property may be protected when you file for bankruptcy and can even be kept. People often believe that you are guaranteed to lose collateral during bankruptcy. But when you file for bankruptcy an automatic stay is placed on your repossessions or foreclosure actions. And with Chapter 7 bankruptcy where your assets are liquidated even a home or car up to a certain value can be saved as long as you’re current with those payments.

If you have more questions about money, credit and debt visit consolidatedcredit.org or call 800-995-0737.

Understanding the value of secured credit cards

If you have bad credit or no credit, it can be a frustrating Catch 22. Creditors want proof that you will use credit lines responsibly before they give their approval. But how are you supposed to prove that if no one will give you a chance?

Secured credit cards are one smart answer to that conundrum. Approval for these types of cards usually isn’t based on credit score. Instead, the creditor simply asks for a deposit equal to the size of the credit line you want. If you want a credit line of $1,000, simply provide a $1,000 deposit and you can have a card to use. Even better, that credit card helps you build credit, so you can qualify for unsecured credit down the road. It usually takes six months to a year, paying off the debt each month, to build your score. Just make sure to make your payments on time every month to avoid creating negative items in your credit history.

Another Misconception: Prepaid and secured are not the same

Another important point to note is that a secured credit card is not the same as a prepaid credit card. Secured credit functions like a traditional unsecured credit card, while prepaid is more like a debit card.

With a secured credit card, you put down the deposit to open the credit line. However, as you make purchases that deposit isn’t touched. Instead you receive a bill at the end of the month with your balance and a minimum payment requirement. The only time your deposit is used is if you default on account and fail to pay back what you owe.

With a prepaid credit card, you deposit money into an account. Then that money is used each time you make a purchase. Your transactions are deducted from the card balance, so there is no bill at the end of the month. Once you use up the balance, you have to add funds to the card. As a result, you don’t build credit with this type of card because there are no bills to create any credit history.

Saving secured collateral during bankruptcy

If you have assets you don’t want to lose during bankruptcy, you have a few avenues that you can take.

Chapter 13 bankruptcy does not liquidate your assets. Instead, the court assigns you to a repayment schedule that’s administered by a bankruptcy trustee. On this plan you repay at least a portion of the debts you owe. Then once you complete the payments your remaining balances are discharged.

With Chapter 7 bankruptcy, assets are typically liquidated. The funds from the sales are used to repay your lenders and creditors. However, assets needed for basic necessities like your home and car can be exempt up to a certain value. Exemptions are usually set by state regulations, so check with a local licensed attorney to see what you may be able to keep.