When it comes to personal finance, debt is any money that you owe. And at the most basic level that can be broken down into 2 main types of debt: Unsecured debt and secured debt.
But you may also hear it as 3 types of debt. That’s because sometimes people break secured debt down into an extra category by separating out mortgages, which are a type of secured debt.
So if you look at it that way, the 3 types of debt are: unsecured loans, secured loans, and mortgages.
(Good debt vs. bad debt is a whole different thing.)
We’ll go over the various types of debt in more detail next, starting with secured debt.
What Is Secured Debt?
Secured debt is when you have something that you put up as collateral in case you don’t repay it. If you don’t repay what you owe as promised, the lender can take whatever you pledged as security. Then they can sell that item to recover at least part of what you owed. That’s why it’s called secured debt.
For example, if you don’t repay your car loan, the lender can repossess your car. If you don’t make your mortgage payments, the lender can foreclose on your house. Either way, you end up without the item that was securing the loan.
Usually secured debt is backed by a physical item, but not always. For example, with secured credit cards or some utilities, the collateral is money that you’ve deposited ahead of time.
Here are some examples of secured debt:
- car loans
- HELOCs (home equity lines of credit)
- car title loans
- secured credit cards
- personal loans (if you pledged something as collateral)
- utility bills covered by a deposit
Secured debts are often installment loans, but not always. (More on that later.) Now let’s move on to the other major type of debt: unsecured debt.
What Is Unsecured Debt?
Unsecured debt is just like it sounds. It’s debt that is NOT backed by property or money that the lender could take if you don’t repay them. (Unless a court orders otherwise. And of course, the lenders would still have the right to collect from you.)
Instead, unsecured loans are made to you based only on your credit worthiness. (Aka how likely the lender thinks you are to repay them.)
Here are a few examples of unsecured debt:
- most credit card debt
- charge cards
- personal loans (if you didn’t pledge anything as collateral)
- student loans
- medical debt
- payday loans
- utility bills (if you didn’t have to leave a deposit)
- paid memberships
If you’re curious, based on the New York Fed’s number of accounts by loan type chart, credit cards are the most common form of debt for US households.
Note that in general, interest rates are higher for unsecured loans vs. secured ones. These unsecured types of debt can be one of any of the 4 types of credit. So on a related note, let’s talk about the types of credit.
What Are the Types of Credit?
Debt and credit are like two sides of the same coin. Except debt is money you owe, and credit is usually money someone is willing to lend you.
The types of credit are broken down into:
- installment credit
- revolving credit
- charge cards
- service credit (sometimes also called open credit)
Let’s talk about each one of those next, starting with installment credit.
Installment credit is where you borrow a set amount and make fixed payments over a set period of time. If you make all your payments on time, at the end of that time the loan is paid off.
Basically, the amount you borrowed plus the interest you’re charged is divided up into a set number of payments that you repay over time.
Mortgages, car loans, and student loans are common examples of installment loans. Installment loans are also sometimes called nonrevolving debt. These usually show up on your credit report, which affect your credit score.
With revolving credit, you have a credit limit. That’s the max amount you’re allowed to borrow at once. (Sometimes creditors will charge you a fee for going over that limit, if they let you do so.) You don’t have to borrow any or all of it, and you can borrow it over and over again as long as you repay it.
In short, with revolving credit you:
- can borrow up to a set limit
- only have to make minimum monthly payments
- and there’s no set date where you have to pay it all off
Credit cards and HELOCs are common examples of revolving debt. Like installment loans, these usually show up on your credit report.
Charge cards are not very common anymore, although American Express still offers some. At a glance they may seem similar to credit cards, but they’re not the same. For one thing, you can’t carry a balance on a charge card. Instead, you have to pay off everything you borrow in full each month.
Charge cards also don’t usually have a a preset spending limit. But “no preset spending limit” doesn’t mean “spend as much as you want”. You could still get declined for large purchases if the lender doesn’t think you’ll be good for it. So it’s a good idea to check with them ahead of time if you’re thinking of spending more than usual
And because there’s no preset spending limit, charge cards aren’t used in figuring out the credit utilization ratio part of your credit scores.
You usually have to have excellent credit to get a charge card. They usually have annual fees (sometimes pretty big ones), and often include rewards.
Service credit is where you’re billed for a service after you’ve already used the service. It’s due in full each month, and you’ll very likely get late fees if you don’t pay on time and in full.
This type of credit isn’t normally reported to the credit bureaus — unless you don’t pay it or are late. Then it’s reported as a negative.
Some examples of service/open credit are:
- phone bills
- gym memberships
The Bottom Line
While having several types of debt/credit can seem confusing, the bottom line is to remember that all debt comes with risk. So you need to be sure you’re ok with the risk if you borrow and can’t repay it, as well as the costs, fees, and repayment rules.
There are some types of debt that should be avoided if at all possible. Payday loans and car title loans are especially bad. The same is true for anything that can end up with a lien on your property. (Like unpaid taxes, casino loans, etc.)
And again, at the most basic level the 2 main types of debt are unsecured debt and secured debt. On a similar note, while there are 4 types of credit, the two you’re likely to care about are installment and revolving. That’s because they affect your mix of credit, which makes up part of your credit score.