Unsecured Credit Definition

Credit accounts involve borrowing money, but many consumers do not realize there are actually two different account types: secured and unsecured. You have unsecured credit if you are one of the 176.8 million Americans who had a credit card as of 2008, according to the Federal Reserve Bank of Boston, or if you are repaying a personal loan. Unsecured credit is beneficial in many ways, but it also carries certain risks for lenders that can make it difficult to get for some consumers.

Definition

Unsecured credit is credit that is extended to a borrower in the form of a loan or credit card without any collateral. Advanced Merchant Services, a merchant account company, explains there is no designated asset for the lender to repossess if the borrower defaults on an unsecured credit account. This makes it much different from secured loans like mortgages, which allow the lender to foreclose on the house if the buyer stops paying, or auto loans, which offer repossession as an option for the financial institution.

Examples

Credit cards such as Visa, MasterCard, American Express and Discover are perhaps the most common examples of unsecured credit. Personal loans which provide funds for an unspecified purpose also fall into this category, as do retail credit lines from department stores and gasoline credit cards.

Benefits

Unsecured credit is beneficial for consumers because they can borrow money without having property or other assets to guarantee the loan. This gives them more buying power and flexibility to use the funds. They can purchase expensive items they could not otherwise afford and pay them off over a period of months or years.

Considerations

It is more difficult to open unsecured credit accounts than to get loans secured by a house, automobile or other property or goods, because there is no collateral for the lender to seize if you do not repay the debt. You need a good or excellent credit score to qualify for most unsecured loans. You may have to pay a higher interest rate and other fees if your credit is borderline. Lenders charge this extra money to offset their increased risk in extending unsecured loans to riskier consumers.

FICO, the credit score provider, explains that unsecured credit is even harder to get in bad economic times. It reports that 51 percent of new cardholders in 2005 had FICO scores below 700. This number dropped to 38 percent in 2008.

Alternatives

Consumers with bad credit can sometimes get a secured credit card by depositing money in a bank account to act as collateral. The account is usually converted to an unsecured account within a year or two if the account holder builds up an excellent repayment history.

Warning

Creditors may be able to garnish your wages or put a lien on your property to satisfy unpaid credit cards and other unsecured accounts. This requires court action and a judgment in favor of the creditor. You may be taken to court if your state allows garnishments and liens and the creditor believes you have enough assets to make the action worthwhile.