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If you have personal debt spread over more than one credit card, personal loan or other form of unsecured credit (for example, a store card) then it can sometimes make sense to consolidate some or all of your total debt into one, more manageable, loan. Here we will take a look at some of the options, and what you will need to take into account if you do decide to apply for a debt consolidation loan.
What is the difference between secured and unsecured lending?
Unsecured lending – such as credit cards and unsecured personal loans – are not secured against a tangible asset. Lenders take this risk into account when setting the interest rates they charge on these types of financial products.
Secured lending is set against a tangible asset as security; in the case of mortgages and secured loans, this asset is your home or any investment property you may own. Having the debt secured against the property means less risk to the lender: in the event that the borrower defaults on the debt repayments, the property can be repossessed and sold to repay the loan.
This means that secured loans usually offer lower interest rates than comparable unsecured lending, but this must be offset against the risk that if you fall behind with your payments, the property used as security could be repossessed.
What are the benefits of debt consolidation?
There can be a number of benefits in using secured loans for debt consolidation. The most obvious is a matter of cost. Unsecured lending interest rates are often several times higher than secured lending rates. It can mean the difference between paying, for example, 19.9% interest on a credit card debt, and 3.9% interest on a secured loan. Depending on the size of the debt, that can make a significant difference to the amount of interest you have to repay each month, and over the total time it takes you to pay off the balance. By lowering the amount of interest you have to pay on your debt, it also has the potential to allow you to pay it off over a shorter term.
Then there is the matter of convenience. If you have, say, two credit cards, a store card and an unsecured loan, then even if you have Direct Debits set up that is still four separate payments, potentially coming out of your account on four separate dates every month. If you do not have Direct Debits for all your payments, then you are potentially paying your monthly bills online, over the phone or even in a bank branch. With a secured loan, this is simplified into a single monthly Direct Debit.
If you have had credit problems in the past, a secured debt consolidation loan can also have advantages over unsecured lending; credit card and unsecured personal loan rates can be particularly high for borrowers with poor credit histories, but with secured lending the lender mitigates a degree of risk by having the loan secured against a property, allowing them to charge lower interest rates.
What are the disadvantages of using secured loans for debt consolidation?
Taking out a secured debt consolidation loan is an ideal solution for many people with unsecured debt, but it is not right in every situation, and is a decision that should only be taken after full consideration of the pros and cons.
The most major potential disadvantage is the risk of securing debt against your property – if your loan repayments fall into arrears, you could lose your home. That is why it is very important to look at your finances very carefully when considering a secured loan; you need to be sure that you can comfortably afford the repayments, and if necessary make provisions for what might happen if you were to lose your job or suffer serious illness or disability.
Secured loans are typically over a longer term – usually from 5 to 30 years – unlike unsecured loans, which typically have a term of up to five years. Repaying your debt over a longer term can make it more affordable, but you need to bear in mind that this means it also extends the term over which you are being charged interest and, in some cases, could even mean that you end up paying more interest in total.
If you are considering a debt consolidation loan, it is a good idea to work out how much you are currently paying in total each month in debt repayments, breaking it down into interest payments, and the amount you are actually paying off your debt. From there, you can work out how long it is likely to take you to repay everything. Once you have those figures, you can compare with secured loan options over various terms, and see whether a consolidation loan would be the best option for you.
As a final point, you need to remember that you can only get a secured loan if you have sufficient equity in your property. If you already have a mortgage with a high loan-to-value ratio, then this might prevent you from getting a secured loan, or limit the amount that you will be able to borrow.