Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Unsecured Creditor

What it is:

An unsecured creditor is a lender or any entity to which a company or individual owes money for services provided. That creditor, however, does not have any collateral from the borrower.

How it works (Example):

If you borrow money from XYZ Bank, XYZ Bank becomes your creditor. Utility companies, health clubs, phone companies, and credit card issuers can all be creditors if you have contracts with them or if they have performed services for which you have not yet paid.

If the creditor has claim to some of your assets -- say, a deposit you made, a lien on your house, the title to your car -- that creditor is a secured creditor. If the creditor has no ability to claim some of your assets when you don’t pay (this is often the case with credit cards), the creditor is unsecured. If you have borrowed money from a bank, the bank may ask you for collateral as a way of securing the loan.

Why it Matters:

An unsecured creditor takes on more risk than a secured creditor because it does not have the ability to seize an asset right away if a borrower fails to repay the debt. Creditors may of course sue to obtain access to accounts or other assets if the borrower has not paid, but that is more expensive than requiring collateral up front.

Regardless, this lack of security increases the creditor’s risk, which in turn increases the interest rates on unsecured loans.