Secured vs. unsecured debt
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| Tue, 01-25-2005 - 4:47pm |
This issue seems to come up fairly often, so I wanted to make a quick point where everyone can see it, concerning the benefits of unsecured vs. secured debt.
Because the banks and financial experts talk about unsecured debt as "bad debt" and secured debt, at least sometimes, as "good debt," a lot of people assume that secured debt is always better than unsecured. But the truth is that secured debt is always better for the *lender,* but NOT always better for *you*.
Here's why. When you borrow money against a car, house, or other item, the bank likes it because if you default, they can take the item away and, presumably, resell it, recouping some of their loss. For that reason, they *usually* offer lower interest rates on secured debt.
The lower interest rates are what make secured debt *sometimes* better for the borrower. But the fact that the lender can take the item away if you fail to pay actually gives the secured debt a significant downside from the viewpoint of the borrower.
If you have two loans with the same balance, same interest rate, and essentially the same terms, but one of them is secured and one unsecured, the unsecured debt is actually the "better" debt from your point of view (and therefore, the secured debt is the one you should probably pay off first). The reason being, if anything happens and you can't make minimum payments, the secured debt will result in your losing the item it is secured against. This is an especially important point in regard to securing debt with a house, as even a bankruptcy won't protect your house if you owe on it, and having too many loans out against your house could easily lead to calamity even if you just miss a few payments. Better to miss a few cc payments and have nasty calls on your answering machine than to miss a few equity line payments and have a repossession notice on your doorstep.
I just wanted to throw that out there, because I think sometimes people pay down their "unsecured" debt first, even when it has better terms, because they think of it as worse debt than the secured items. But if your ccs are on 0% (or low rate) offers, my recommendation is generally to go ahead and pay the car note or equity line, and worry about the ccs later. Besides, if your credit is good enough to be receiving 0% offers, you can probably surf that 0% balance over to another 0% offer when the intro rate expires.
Also, of course, I never suggest a home equity line to pay off ccs. A very, very dangerous path.
Thanks for listening,
Heather

Good points. The only thing I would add is that in some states, if you go to bankruptcy, you can keep your house. FL is one of them. I am not sure about the others. I just remember that when some of the ENRON bigwigs were declaring bankruptcy, a big deal was made that one of them wouldn't have to give up his million dollar house because the bankruptcy court couldn't touch it. Then again, you don't make the payments, the bank can still take it.
Kellie