What differentiates secured debt from unsecured debt?

Secured debt is characterized by the presence of collateral, which is a valuable asset that a borrower agrees to forfeit in the event they default on the loan. This collateral can be anything of value, such as a car or a house, that the lender holds a claim to, ensuring that they can recover their losses through the sale of this asset if the borrower fails to repay the debt. The presence of collateral reduces the risk for lenders, which is why secured debt often comes with more favorable terms compared to unsecured debt, such as lower interest rates.

Understanding the role of collateral is crucial, as it is the defining feature that separates secured debt from unsecured debt, which does not have any collateral backing and is based purely on the borrower's creditworthiness and ability to repay. This fundamental difference impacts the terms and conditions associated with each type of debt.