Definition of Unsecured Debt

• Credit cards are considered to be a form of unsecured debt. This is distinct from mortgages and car loans, which are considered to be secured debt. It is easiest to understand unsecured debt by first understanding what secured debt is. When you borrow money to buy a house or a car, that money is "secured' by the house or the car itself. In other words, the house and car provide collateral for the loan. If you do not make your mortgage or car payments, the lender can take the house or take the car and sell it to get the money you owe. Credit cards, on the other hand, are not secured by anything. You can put plane tickets or groceries on a credit card--which means you are borrowing money to buy plane tickets or groceries--and there will be nothing for the bank to take or to sell if you decide not to pay back the money you owe. Because unsecured debt is riskier for the lender, the interest rate on unsecured debt is usually higher than the interest rates on secured loans.
  
  

Interest Rates

• The interest rate refers to the amount you are paying for the privilege of borrowing the money, or using your credit cards. The majority of credit card companies specify the "interest rate" in annual terms. In other words, your interest rate might be 10 percent APR (annual percentage rate). However, assuming that just because you borrow $100 you will owe $110 on the end of the year is not correct. Determining how much interest you actually pay on a credit card is more confusing, because some companies charge interest based on average daily balance, while others charge based on average monthly balance or use a two-month cycle to determine your interest. Furthermore, you pay interest on unpaid interest as well. If you have questions about the terms of your interest rate, it is best to discuss those questions with your specific credit card issuer prior to signing up for a credit card. In general, though, the important thing to know is borrowing money is not free, and the more you borrow the more you will pay for the privilege of doing so.
  
  

Credit Lines

• Your credit line or line of credit refers to the maximum amount you have available to charge on your credit card, or the maximum amount you have available to borrow. This is usually decided by the credit card based on your salary and your credit score. If you charge up to the limit, it is called "maxing out" your credit card. Maxing out your credit card can lower your credit score. If you try to borrow more money than you have available to you, you are exceeding your credit line or going over the limit. Typically, there are fees and penalties associated with this behavior.
  
  

Monthly Payments

• When you borrow money on a credit card, you have to pay a bit of it back every month. Credit card companies set a minimum monthly payment that you have to pay, based on how much you owe. Often, the minimum monthly payment is much lower than the balance you carry. If you have a high balance, the minimum monthly payment may not even cover the interest you are being charged. If you pay only the minimum monthly payment on your credit card, you may be making payments and the amount you owe may actually be increasing. It may take you many years to pay off a credit card balance in full, and you may end up paying much more in interest than you originally borrowed if you pay only the minimum monthly payments. However, you must pay at least the minimum monthly payments or you will be charged fees and penalties, and your credit score will be adversely affected.
  
  

Credit Scores

• Your credit score determines whether you are credit-worthy enough to qualify for a credit card or other loan. Your credit score, or your FICO score as it is sometimes called, is determined by your borrowing behavior. Thirty-five percent of your score is based on your payment history--whether you pay on time or whether you have had any judgments against you or declared bankruptcy. This is why it is important to pay your credit cards on time. Thirty percent is based on how much you owe. Lower numbers are better, which is why it is important not to "max out" your credit cards. Fifteen percent is based on the average age of your credit cards. This is why it is better not to open a lot of new credit cards. Ten percent is based on inquiries- each time you apply for a new credit card or a new loan, an "inquiry" shows up on your credit report. Fewer inquiries equals a higher credit score. Finally, the last 10 percent is based on how many different kinds of credit you have; it is better to have a mix of secured debt, like mortgages and car loans, and unsecured debts, like credit cards.