Unsecured Debt

Key takeaways

• Unsecured debts are loans not backed by collateral.
• Lenders charge higher interest rates because they have limited protection if borrowers default.
• When borrowers default, lenders may report the debt to credit agencies, hire collection agencies, sue, or sell the debt on the secondary market.

What is unsecured debt?

Unsecured debt refers to credit extended without a specific asset pledged as security. If a borrower defaults, the lender cannot repossess property tied to the loan. Because of this increased risk, unsecured loans typically carry higher interest rates than secured loans.

Common examples

• Credit card balances
• Medical bills
• Utility bills
• Personal loans issued without collateral

Why unsecured loans cost more

Lenders face greater risk when loans are unsecured. To compensate, they set higher interest rates and may use other risk-mitigation methods, such as stricter underwriting, higher fees, or requiring stronger credit qualifications.

What happens when a borrower defaults

If a borrower fails to repay unsecured debt, possible outcomes include:
* Reporting the delinquency to credit bureaus, which harms the borrower’s credit score.
Filing a lawsuit to obtain a judgment; recovery can be difficult if no assets are available.
Hiring a collection agency to pursue repayment on a contingency-fee basis.
* Selling the debt to an investor on the secondary market at a steep discount.

Bankruptcy may discharge unsecured debts, but it carries long-term credit consequences and can make obtaining future loans difficult.

How lenders recover unpaid unsecured debt

• Credit reporting: Lenders can report defaults to credit rating agencies to pressure repayment and affect the borrower’s future borrowing ability.
• Collection agencies: Lenders often hire third-party collectors who work on contingency; collection fees vary widely (roughly 7.5%–50% of recovered amounts, with consumer accounts commonly around 35%).
• Selling the debt: Lenders may sell delinquent accounts to debt buyers for a fraction of face value, transferring the recovery risk to the buyer.
• Litigation: Suing a borrower can sometimes secure a judgment, but without collateral the practical ability to collect may be limited.

Example

A lender issues a $20,000 unsecured personal loan. When the borrower falls behind on payments, the lender must weigh options: pursue litigation (which may be impractical without collateral), hire a collection agency and pay its contingency fee, or sell the debt to an investor at a discount. Each option has trade-offs in expected recovery and cost.

Conclusion

Unsecured debt provides borrowers with access to credit without pledging assets, but it exposes lenders to greater risk—reflected in higher interest rates and more aggressive recovery tools. Borrowers should understand the potential credit consequences of default and the limited remedies available to lenders when no collateral exists.