October 22, 2014

Debt Elimination – Where to Begin?

What kinds of debt do I have? The road to debt elimination begins with answering this question.

In the world of debt, there are two general kinds, secured and unsecured. An understanding of the consequences associated with each debt and of the unique combination of debts you hold is essential to the resolution of your financial circumstances.

A secured debt is guaranteed or “secured” by some form of collateral put up by the borrower. This collateral is something for the creditor to seize to get their money back if the borrower defaults. The most common forms of secured debts are mortgages or auto loans with the collateral being the home or car. Defaulting on either of these loans could result in foreclosure or repossession by the lender. In exchange for the lowered risk to the lender because of this ability to take something from you upon default, secured loans generally come at a lower interest rate. Payments on a secured debt are usually made on a set schedule, at a set amount, and at a fixed interest rate until the debt is paid off.

An unsecured debt, in contrast, involves no collateral but instead is based on a contractual agreement entered into by the borrower and lender at the beginning of the relationship. Common examples of unsecured debts are credit cards, medical bills, student loans, or utility bills. The risk of default on an unsecured loan is that your debt could be turned over to a collection agency and a lawsuit may be filed against you for repayment. Lenders of unsecured debt will be more stringent about pursuing repayment because their money has not been guaranteed. Unsecured debts generally have higher interest rates because of the increased risk taken on by creditors. Take credit cards, for instance – the average interest rate on credit cards today is around 14.9 percent. Payments made on unsecured debts usually fluctuate based on the outstanding balance.

What is the best combination of debt types? Is having just secured better?

You may be thinking that if it means you will be pursued less stringently and receive a lower interest rate, then having just secured debts must be better. In reality, having just secured debt is not always the best idea. Instead, it may be in your best interest to keep your loans separate where you can, so that a risk of late payment on a credit card secured with a home equity line of credit does not mean the loss of your home.

When you have both kinds of debt, how should you prioritize payment?

As a general rule of thumb, secured loans usually come first on your list for payment. If you own a home, your mortgages or home equity line of credit are often at the top of your list in order to avoid foreclosure and the loss of your home. Similarly, if you don’t own a home but have a car loan, this is usually your top priority. Being in debt is already hard enough, and losing your car would only make matters worse by making it hard for you to get to work. Not to mention with the depreciation in value of cars on the market you could end up having to pay the difference between your original sale price and the amount obtained at auction.

If you have student loans backed by the federal government in repayment, these loans are also typically near the front of the line for payment. Federal student loans are unique in that they are a debt unsecured by you personally but secured by the government, meaning the government has guaranteed your lenders they will be repaid. This guarantee may result in a lien on your federal income tax return, wage garnishment, or prevention of your ability to obtain future loans, should you default on your student loans.

Finally, any unsecured debt is typically at the end of your list. This is not to say that unsecured debt payments should be delayed by any means, but just that if you have to choose, people will usually pay secured debts first. Unsecured debt may expose you to collection calls and future legal action, but default on these may not have the immediate ramifications that defaulting on secured loans can.

If you need help determining where you stand and what your debt elimination options are, contact McCarthy Law today to set up a free consultation. We have a team of experienced debt settlement attorneys who can review and analyze your current financial situation and get you on the path to debt resolution.

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