In finance, unsecured debt
refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment.
In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors. The unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors.
In some legal systems, unsecured creditors who are also
indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.
Under risk-based pricing, creditors tend to demand extremely high interest rates as a condition of extending unsecured debt. The maximum loss on a properly collateralized loan is the difference between the fair market value
of the collateral and the outstanding debt
. Thus, in the context of secured lending, the use of collateral reduces the size of the "bet" taken by the creditor on the debtor's creditworthiness. Without collateral, the creditor stands to lose the entire sum
outstanding at the point of default, and must boost the interest rate
to price in that risk. Where high interest rates are considered usurious, unsecured loans are either not made at all, or are made by loan sharks unafraid of the law.
Unsecured loans are often sought out in cases where additional capital is required although existing (but not necessarily all) assets have been pledged to secure prior debt. Secured lenders will more often than not include language in the loan agreement
that prevents debtor from assuming additional secured loans or pledging any assets to a creditor.