A debt consolidation loan is worth exploring if a person is overwhelmed with multiple debts and wants to combine them into one monthly payment. Debt consolidation loans can be secured or unsecured through a bank, credit union, or an online lender. Both options could help someone save money on interest and streamline their debt payoff journey.
So what is a secure loan, and what is an unsecured loan? This article will take a closer look at the difference between both options so that borrowers can choose the right one for their financial needs.
How a Debt Consolidation Loan Works
A debt consolidation loan is a way to pay off multiple debts that typically have high interest using a new loan. Ideally, the borrower would secure a new loan with a lower interest rate and better terms than what they currently have so they can save as much money as possible. Instead of having to keep track of and make multiple debt payments, the borrower would only be responsible for one payment every month.
Secured Loans for Debt Consolidation
Secured loans are secured by collateral or something valuable a borrower owns, like a house or car. If they default on a secured debt consolidation loan, the lender has the right to seize their collateral to recoup their losses.
A secured debt consolidation loan could be ideal if the borrower is confident they’ll be able to repay the debt consolidation loan according to their new repayment schedule. If not, they may lose a valuable asset. Some examples of secured loans that can be used for debt consolidation include:
- Secured personal loans: Secured personal loans require collateral and can be ideal for those who may not qualify for an unsecured loan. Secured personal loans may also offer higher borrowing limits and lower interest rates.
- Home Equity Loans: Home equity loans allow borrowers to tap into their home equity, which is the value of their home subtracted from the amount they owe on their mortgage. If the borrower defaults on a home equity loan, they may lose their home.
Unsecured Loans for Debt Consolidation
Unlike secured loans, borrowers don’t need collateral to get approved for an unsecured loan for debt consolidation. This is great news if they don’t own any valuable assets or wish to protect the ones they have. Two types of unsecured loans for debt consolidation include:
- Unsecured Personal Loans: An unsecured personal loan does not require collateral to secure funds. When approving their application, the lender will typically review the borrower’s creditworthiness and ability to repay the loan.
- Balance Transfer Credit Cards: A balance transfer credit card allows borrowers to transfer their high-interest credit cards or personal loans to another card, typically with a lower interest rate. Some balance transfer cards offer a low or 0% introductory APR period, usually between 12 to 21 months. If the borrower does not pay the balance before the intro period ends, the APR will increase to the standard rate.
The Bottom Line
The ideal debt consolidation loan depends on a person’s unique situation. If they don’t want to risk losing a valuable asset, like their house or car, an unsecured loan may be a better option if they meet the qualifications. On the flip side, if the borrower believes they will be able to repay the loan and have no problem securing it with collateral, they might benefit from a secured loan.
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