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Secured vs. Unsecured

IT’S HELPFUL to think about your debts in two buckets: secured and unsecured. What’s the difference? Secured debt is backed up by an asset you own. For instance, your mortgage is secured by your home, your brokerage-account margin loan by your portfolio and, in most cases, your auto loan by your car. Because lenders have an asset they can seize if you fail to make your debt payments, the interest rate tends to be relatively low.

Personal bank loans and credit card debt are unsecured, hence the relatively high interest rates charged. Those high rates are needed to compensate lenders for the money lost to defaults. What about education loans? Those might also appear to be unsecured. But with federal education loans, the government has ways of reclaiming its money—including asking your employer to garnish your wages, taking your federal and state tax refunds, and even garnishing your Social Security retirement benefit.

If possible, avoid unsecured debt and instead favor debts that are secured by an asset, so you pay a lower interest rate. That, however, isn’t the only consideration: You’ll also want to consider taxes.

Next: Deducting Interest

Previous: Debt Ratios

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