Q: What is the difference between secured and unsecured debt?
A: Secured debt is debt that uses some form of collateral, such as a home, to ensure that the debt will be paid. The most common example is a mortgage against a residence. When filed properly with the appropriate county recorder’s office, a mortgage creates a lien against the property that must be paid if the property is sold or transferred to someone else. If your house is mortgaged, and you fail to make payments, you may lose your house through a foreclosure process.
Unsecured debt has no collateral pledged to secure repayment. Credit card debt is the most common example of unsecured debt.
Q: Is a home equity loan secured or unsecured debt?
A: It depends. Typically, home equity loans are intended to be secured by the equity in your residence. A mortgage securing a home equity loan, however, is generally not the first mortgage to be filed against the property. Because it is not usually the first lien filed, whether or not it is considered secured debt depends on the value of the property and the amounts of any prior liens. The intent of the lender is that the home equity loan will be fully secured, that is, the value of the real estate will be sufficient to cover both the first and second mortgages (the home equity loan mortgage). However, that is often not the case. Real estate appraisals vary substantially, and the real estate property values fluctuate. Therefore, while the mortgage securing the home equity loan should be fully secured, sometimes it is not.
Unless they have received a discharge of debts in a bankruptcy proceeding, the signers of the mortgage will be personally liable for any deficiency, which results from a sale of the property for less than the amount of the liens filed against the property. Mortgages securing home equity loans can create this risk, because often they are not fully secured. This can lead to a bankruptcy filing when the borrower is unable to make the payments.
Q: What are some of the disadvantages of home equity loans?
A: Home equity loans are advertised as a way to consolidate credit card debt. By consolidating credit card debt into a home equity loan, consumers are transforming unsecured debt (namely, credit card debt) into secured debt (namely, a mortgage). Failure to make the payments can result in the foreclosure, and ultimate loss, of the residence. Home equity consolidation loans work well when the consumer does not incur additional credit card debt, but work miserably when the consumer continues to spend.
This "Law You Can Use" legal information column was provided by the Ohio State Bar Association. It was prepared by attorney Susan L. Rhiel, shareholder in the Columbus firm, Rhiel & Associates Co LPA.