Secured vs. Unsecured Debt

GUYS! I am so stoked! People are reading and responding! Thank you so much for reading and re-tweeting and Instagram liking my posts! It makes me so happy!

Last week I posted about HELOCs (you can read my initial post here) and I’ve gotten a lot of comments and e-mails about my initial post!

Many of you agreed with me, but some of you didn’t! And that’s okay! I thought I’d break down a very awesome comment from Facebook.

A Facebook reader writes:

“As much as I agree with her argument, it’s a pretty one-dimensional one. She only discussed using a HELOC to buy something. We took out a HELOC to pay off high interest debt and consolidate. It’s saving us $600 a year in interest. Not good for everyone, but it’s not the worst thing.”

Congratulations, Reader! You are getting your debt under control and that is awesome! I hope you’re very proud of yourself!

But, one thing I didn’t talk about in my last post (but again, came up on Facebook) is the difference between secured and unsecured debt.

Secured credit or debt, is debt that is secured by an asset you own. If you do not pay your mortgage, the bank can take your home because the house is securing your debt. Same thing with an auto loan.

Credit cards are unsecured debt. Meaning, there is no fixed asset associated with them. If you don’t pay your credit card bill, the credit card company can come after you for the balance, but they can’t take your home or you car away from you. They can, and probably will, call in a collections agency and may take you to court to get their payment, but for the most part your credit card debt is not going to affect your housing or transportation situation.

The problem with HELOCs is that they are secured debt. You’re using your home as collateral for taking out that line of credit. If you can’t pay back your HELOC, for any reason, the bank can (and probably will) come after your home.

There is one other comparison we can make between credit cards and HELOCs, though. Both of these are usually revolving lines of credit. Meaning you can borrow money, pay it off, borrow it again. With a credit card there is no limit, but with a HELOC there might be a set time period (10 years).

Because credit cards are unsecured lines of credit they usually have higher interest rates than a HELOC. Because a HELOC is secured it can afford a lower, variable interest rate. This can be really appealing for people. Yes, I have a high enough limit on my Amex to renovate my entire kitchen, but the interest rate is way higher than it would be if I took out a HELOC for the same amount.

Now, should you use a HELOC for debt consolidation? Well, that depends. The reader above notes that they’re saving $600 a year on interest payments. That’s a pretty good chunk of change.

BUT, if you’re consolidating credit cards or even student loan debt and paying that debt off with your HELOC, you’re taking unsecured debt (because student loans are also unsecured) and turning it into secured debt.

That’s really risky. Because if you default on those payments you can now lose your house.

For some people, the smaller monthly payments of the HELOC can provide the breathing room they need to finally pay off their debt once and for all. And that is always a good thing.

But for those folks who have variable income, aren’t committed to fixing the issues that got them in debt in the first place, or who are living paycheck to paycheck, trading in unsecured debt for secured debt is not something I’d recommend.

What do you think? Is this a fair assessment?

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