Whether you are on the edge of bankruptcy or looking for a way to manage your finances better, debt consolidation is a good option for you. What is debt consolidation?
It refers to taking out a single loan to pay off much smaller ones, which leaves you with a single monthly payment. The goal of consolidating debt is to pay lower rates of interest, thereby eliminating your debt faster.
You should know that debt settlement is not the same as debt consolidation. In the latter, you will pay your debt in full without seeing any negative consequences on your credit.
Unsecured vs. secured loans
When you take out a secured loan, you pledge your property to secure your loan repayment. For instance, when you take out a mortgage loan, your house will act as security for your repayment. If you default on your payments, the lender can foreclose your property to satisfy the loan.
On the other hand, unsecured loans are based on your promise to repay and do not have any collateral. Credit cards are types of unsecured loans. Because these loans carry more risk for the lender, they tend to have higher rates of interest.
Secured loans for debt consolidation
When looking to consolidate debt through secured loans, you can take out a second mortgage, refinance your house, or get a home equity line of credit. Using your car as collateral, you can also take out a car loan. There are many other types of secured loans, including 401k loan that takes your retirement fund as collateral.
Do you have a life insurance policy that has cash value? You can obtain your loan against it. Any of these secured loans can be used to consolidate debt but are they the right choice?
Secured loans often carry lower interest rates than their unsecured counterparts, which means that you could save money on interest. Lower rates of interest will make your monthly payments more affordable. In some cases, the interest payments can be tax deductible.
For instance, if you take out a loan secured by real estate, the interest paid is tax deductible. A single payment with a lower rate of interest will ease your financial burden significantly. Moreover, secured loans are easier to obtain as they carry less risk for lenders.
When you pledge your assets as collateral, you risk losing them. If you fail to pay the loan back, you will lose your retirement fund, car, life insurance, or house. Assets such as retirement funds and life insurance might not be available for use until your loan is fully repaid.
The term of secured loans might be longer than that of the debt that you consolidated. This means that the interest that you pay over the life of your secured loan might be more than what you would have paid on your consolidated debt.
Unsecured loans for debt consolidation
People are less likely to use unsecured loans to consolidate their debts because their rates of interest are high. Zero percent APR credit cards are a substitute for unsecured personal loans in debt consolidation.
When you use an unsecured loan, no property will be at risk. Even if the interest will be higher than for secured loans, it is still less than what you would pay on different credit card balances.
Unsecured loans for debt consolidation are hard to get if you have bad credit. If you need debt consolidation, chances are that you do not qualify.
Before you choose any option, you should get advice on debt consolidation program pros and cons from a financial adviser.