What Are the Types of Debt?

"Debt" comes in many shapes and forms, such as mortgage loans, vehicle loans, credit cards, personal loans, and medical debt. If you fail to pay a bill, the type of debt you owe determines what collection actions the creditor can take to get their money back.

So, to effectively manage your debt, you need to understand the different types, how they work, and how the creditor can collect if you don't pay.

What Are the Most Common Types of Debt?

Generally, debts fall into one of two main categories: secured or unsecured.

• Secured debts. When getting a large loan, it's common to agree to put up property (collateral) to ensure you'll repay the lender. This type of loan is known as a "secured debt."
• Unsecured debts. A debt is unsecured if you borrowed money without pledging any property as collateral.

Debts then fall into various subcategories under these general categories, such as revolving debt and installment debt.

More About Secured Debt

Collateral not only gives the lender a sense of security, but it also provides the lender with actual ownership rights in the property in the form of a lien. The lien remains on the property until you repay the loan or obligation.

In most cases, the property pledged as security remains with the borrower. You'll retain ownership if you follow the contract agreements made when taking out the loan. Staying current on the monthly payment is the most common requirement, but you might have to maintain insurance or abide by some other condition.

When You Don't Pay a Secured Debt

Secured debts, like mortgages and car loans, give the creditor special rights to collect from property that you've pledged as collateral for the loan. If you don't pay a secured debt, the lender can take steps to collect from the pledged property through foreclosure or repossession.

For instance, when taking out a car loan, most borrowers agree to give the lender a lien on the car. If the borrower fails to pay, the lender can repossess the vehicle, sell it at auction, and use the proceeds to pay down the loan. But, the borrower will keep the car as long as the car loan payments remain current.

A home purchase is another type of secured debt. The borrower agrees to use the house as collateral. The lender gets a lien on the property, which allows it to foreclose on the home after a contract breach.

Types of Secured Debts

Here are more examples of secured debts:

• Judicial lien. A creditor with unsecured debt can turn it into secured debt by getting a money judgment. For instance, suppose a credit card lender files a lawsuit against a borrower. If the creditor is successful, the court will issue a judgment. The creditor can secure the debt by filing the money judgment against the judgment debtor's real estate and personal property. Some states give the judgment creditor a lien on the judgment debtor's property automatically.
• Statutory lien. In some cases, a creditor gets a lien by law. For instance, if you don't pay your taxes, the IRS can take steps to put a lien on your property without going through the court system. Some tradespeople also have the right to an ownership interest in your property if you fail to pay as agreed. An example would be a mechanic's lien.
• Pawnshop loan. The procedure is a bit different when you borrow money from a pawn shop. You'll leave the pledged property, such as jewelry or a watch, with the pawnshop until you've repaid the loan. You'll lose the property if you don't make the payments on time.

Pros and Cons of Secured Debt

One advantage to taking out secured debt is that you might be able to get a large loan. Because the lender can foreclose or repossess the property you use as collateral, the lender knows it will get its money back by selling the item if you don't make the payments.

Also, because a secured loan has less risk for the lender, you might be able to get a lower interest rate. And you might qualify for a tax deduction on the interest in some cases, like if you take out a mortgage or get a home equity loan.

Of course, the downside to secured debt is that you can lose the property you used as collateral if you don't pay.

More About Unsecured Debt

Unsecured debts don't involve collateral. Some common examples of unsecured debt are:

• credit card debt (although a credit card can be secured)
• medical bills
• utility bills (with no deposit), and
• personal loans.

In each case, the lender can't take the property you bought on credit, or any other property, without doing more.

Taxes and federal student loans are also unsecured. But the government gets special collection rights. In most cases, the government can take your tax refunds to pay the debt and garnish your wages or Social Security without first obtaining a lawsuit judgment.

If You Don't Pay Unsecured Debt

Just because a debt is unsecured doesn't mean you don't have to repay it. If you don't repay an unsecured debt as initially agreed, the creditor you owe money to can:

• ask you to pay using phone calls and letters
• hire a collection agency to try to collect the debt, and
• report your failure to pay (or late payments) to a credit reporting agency.

But unsecured debts generally require the creditor to file a lawsuit against you and get a money judgment before it can take drastic collection actions. Without a money judgment, the creditor can't take your property, sell it, and use the proceeds to pay down the debt.

Turing an Unsecured Debt Into a Secured Debt

Once the creditor has a money judgment, it might be able to garnish your wages, levy your bank account, or place liens against real estate you own.

In that case, you might be able to protect some of your property by using exemption laws to keep it out of the hands of creditors. State exemption laws allow you to keep property away from creditors, both in collection actions and if you file for bankruptcy. The exemptions you can use will be the same in most, but not all, states.

Pros and Cons of Unsecured Debt

One upside to unsecured debt is that you don't risk losing any collateral if you don't make payments. (But if you default, the lender can go to court to get the money you owe and, potentially, get your property that way.) And because you're not putting up any collateral, the process of getting unsecured debt is usually less complicated than getting a secured loan.

But unsecured debt, like credit cards, usually has a higher interest rate than secured debt. Because the creditor would have to sue you if you don't pay, this kind of debt presents more risk and costs for the lender.

Revolving Debt

A "revolving debt" is an open line of credit. You can borrow up to a specific limit.

The available amount of credit fluctuates each month, depending on how much you use it. If you pay the minimum amount each month, you can continue to use the credit. But if you only make the minimum payment, which may change monthly, you'll pay interest on the balance.

Revolving debt can be secured or unsecured. Different types of revolving debt include a home equity line of credit, credit card, and store card debt.

Non-Revolving/Installment Debt

With non-revolving debt, also called "installment debt," you borrow a specific amount of money and pay it back in installments before a particular date. Payments are usually the same amount each month.

Installment debt can be secured, like an auto loan or mortgage, or unsecured, like a federal student loan.

Sneaky Debt

"Sneaky" debt is pretty much what it sounds like: debt you incur for purchases that generally aren't financed, like furniture or exercise equipment. Because this type of debt is usually secured, you could lose the item you financed if you don't make the payments.

Instead of financing these kinds of purchases, you'd be better off saving up and paying for the item in cash.

Which Debts Should You Repay?

It's more important to pay some debts than others. Your options and best strategies often depend on the debt type.

If you can't keep up with all of your debt payments, first, figure out which ones are high priority, medium priority, and low priority. Pay the high-priority debts first.

Only pay low-priority debts if you've already paid the high-priority ones, even if your creditors insist you pay them.

High-Priority Debts

High-priority debts are secured by collateral you want to keep, like a house or a car. In some cases, certain unsecured debts, like utility bills, child support, and federal student loans, are also a high priority.

High-priority debts ordinarily include:

• Mortgage. You'll likely lose your home to a foreclosure if you don't make the mortgage payments. If you're having trouble staying current, you might be able to get a loan modification and a more affordable monthly payment. If you've lost your job or had another financial setback, carefully consider whether you should sell your house and rent a moderately priced place. You can then use what's left over to pay your other essential bills.
• Child support. Failing to pay child support can land you in jail. What's more, a child support debt never goes away—it doesn't expire, and you can't wipe it out in bankruptcy.
• Utility bills. Being without gas, electricity, heating, water, or a telephone isn't safe. Put these bills near the top of your list for repayment.
• Car payments. If you need your car to keep your job, it's best to keep up with these payments. If you don't need a car to get to work, consider selling the vehicle or voluntarily turning it over to avoid repossession. You might be able to use any leftover money to buy a cheaper car.
• Other secured loans. If you don't pay a secured debt back, the creditor might be able to come and get the property without first suing you in court. If the item is something you can't live without, make the payments. Otherwise, don't be too concerned about missing a payment or two. Keep in mind, though, that a default or repossession will show up on your credit report for seven years and will affect your ability to get credit in the future.
• Federal student loans. Paying your student loans is sometimes essential, like when the IRS is about to intercept your tax refund, the holder of your loan threatens to garnish your wages, or you're making payments under a repayment plan to rehabilitate your loan and get out of default.
• Unpaid taxes. If the IRS is about to take your paycheck, bank account, or other property, immediately contact the IRS to work out a repayment plan.

Medium-Priority Debts

Some debts straddle the line between high and low priority. When deciding whether to pay these debts, consider various factors, like your relationship with the creditor and whether the creditor has initiated collection efforts.

Medium-priority debts generally include:

• Medical insurance or bills. If you're under a physician's care, you'll want to continue making payments.
• Credit cards. If you don't pay your credit card bill, the worst that will happen before the creditor sues you is you'll lose your credit privileges. But penalties and interest add up quickly. And falling behind in payments will damage your credit.
• Court judgments. Once a creditor gets a judgment against you, the creditor can generally collect it by garnishing your wages or levying your bank account. If a particular judgment creditor is about to grab some of your money, the fact that the debt was originally low-priority doesn't matter.

Low-Priority Debts

A low-priority debt doesn't have immediate or devastating effects if you don't pay. While paying these debts is a desirable goal, they're usually not a top priority.

For example, low-priority debts typically include:

• Department store and gasoline charges. If you fail to pay these bills, you'll probably lose your credit privileges, and if the debt is large enough, you might face a lawsuit.
• Loans from friends and relatives. You might feel like you need to repay these kinds of loans, but your friends and relatives are most likely to understand that you're in a tight spot.
• Other unsecured loans. Again, an unsecured debt is one that doesn't have collateral; a creditor can only take your property after first suing you in court.

However, failing to pay a debt causes it to stay on your credit reports for seven years.

Read More Articles

See Options for Dealing with Your Debt to learn about different ways to deal with outstanding debts.

For more information about how to deal with debts, read When You Can't Pay Your Bills: Things to Know.

If you need help deciding what to do, see Options If You Can't Pay Your Debts.

Talk to a Debt Settlement Lawyer

If you need help deciding which course of action is best for managing your debt, consider consulting with a debt settlement lawyer.