Unsecured debt is a term you may not have heard of, but it is in fact, one of the most common types of debt. The term unsecured debt, as opposed to secured debt, deals with collateral. For example, when you take out a loan to buy a car, you receive an installment loan that is secured by the car itself. If you default on your car loan, the car is repossessed. This is a perfect example of secured debt.

Unsecured debt, on the other hand, has no collateral. The type of unsecured debt that is most prevalent is the credit card.  When you borrow using your credit card, you are accruing what is known as unsecured debt because there is no attached collateral. If you default on your credit card balance, there is no specific asset that you own that is seized.

The way the unsecured debt is granted and utilized differs widely from secured debt. With secured debt, it is easy to determine the interest rate and the credit line, as it is often commensurate with the value of the collateral. However, with unsecured debt, there is no collateral, therefore no basis for determining the terms of the loan.

Unsecured debt decisions rely largely on your credit rating. When lenders determine how much unsecured debt to grant you, they will look at your credit report and will also sometimes consider your assets and income. The idea behind this is that you are banking on your reputation as a borrower, rather than the value of an asset. If you can prove that you have  been responsible and timely in repaying your loans, you will get more favorable rates for your unsecured debt. If you have a poor credit history, you may not even be able to draw unsecured debt.

Because unsecured debt is somewhat vaguer territory, there are more pitfalls for both borrower and lender. For the borrower, unsecured debt gives them the ability to spend beyond their means. You can easily find yourself deep in debt if you do not utilized unsecured debt responsibly. Lenders, on the other hand, run the risk of having borrowers default on unsecured debt and have no means to repay it. Lenders then must send items to collections and have no recourse other than to file a lawsuit or force the borrower into bankruptcy. Both of these methods for collecting on unsecured debt are time-consuming, complicated and costly.

In order to subsidize the risk inherent in issuing unsecured credit, lenders almost always affix stricter terms on unsecured debt than secured debt. This is important to keep in mind when you are shopping around for the best rates on a loan. If you choose to seek unsecured debt, then it is in your best interest to improve your credit rating as much as possible. You may even wish to enlist the services of a credit repair specialists or a credit counselor. The fee that these professionals charge may pay for itself if you can get better rates on a loan.