Secured vs. unsecured debt consolidation loans

It can be challenging to manage multiple debt accounts at once, but you may be able to find relief with a debt consolidation loan. They are readily available through traditional banks, credit unions and online lenders and come in two forms: secured and unsecured loans.

Secured and unsecured debt consolidation loans can help you shave several months or even years off your repayment period. Furthermore, you may save a bundle on interest by getting a debt consolidation loan with a more competitive interest rate.

What is a debt consolidation loan?

A debt consolidation loan is a personal loan or other credit product used to roll several debt balances into one new loan product. Depending on which debt consolidation option you choose, your loan might be secured with collateral or unsecured.

You can use a personal loan calculator and credit card payoff calculator to compute potential interest savings with a debt consolidation loan. Ideally, the interest rate on a debt consolidation loan should be lower than what you currently have to maximize cost savings.

Secured debt consolidation loan

As the name suggests, a secured debt consolidation loan requires collateral for approval. By putting up collateral, you reduce the risk the lender assumes. This can lead to several benefits, such as easier approval, lower rates or a larger loan amount. The drawback is you risk losing your property if you fail to keep up with payments.

Unsecured debt consolidation loan

Unsecured debt consolidation loans do not require collateral. The loan amount and terms you receive are based on your creditworthiness and financial profile. The upside is your assets are not at risk if you fall behind on payments. But your borrowing costs could be higher, as these loans pose more of a risk for lenders.

Secured debt consolidation loan options

Secured loans are backed by collateral, making them riskier for borrowers. Collateral is an asset that is used to guarantee a loan — if you default on the loan, your lender could take your collateral to repay what you owe.

Despite their risk, debt consolidation for secured loans may be worthwhile, depending on your financial situation. You can use any of these secured loan products for debt consolidation.

Secured personal loan

A secured personal loan operates much like any other personal loan and can be easier to access if you have fair or bad credit. Because your collateral reduces the lender’s risk, you may be offered a lower personal loan interest rate than you would with an equivalent unsecured loan.

Still, there are downsides to consider. You could get a hefty interest rate and risk losing your collateral if you fall behind on the loan payments.

Home equity loan or home equity line of credit (HELOC)

Both home equity loans and HELOCs let you convert a portion of your home’s equity into cash. Equity is the difference between what your home is worth and what you currently owe.

If you take out a home equity loan, you’ll receive the entire amount you borrow in a lump sum and repay in equal monthly installments. The interest rate is fixed. A HELOC, on the other hand, acts like a credit card. You can pull funds from it as needed. You’ll only repay what you borrow from a HELOC, and the interest rate is variable.

Both home equity loans and HELOCs are excellent for debt consolidation. They may offer more competitive interest rates than a comparable personal loan. Plus, you may get approved for a large amount if you have a lot of equity in your home.

They are not without risk, however. The biggest drawback is you could lose your home to foreclosure if you default on the loan, since these products act as second mortgages.

Unsecured debt consolidation loan options

Unlike secured loans, you won’t need to put up collateral to get approved for these credit options. Because of this, lenders rely heavily on your credit profile, income and job history to make decisions.

Unsecured personal loan

This loan product allows you to consolidate your debts to simplify the repayment process. You’ll get a fixed interest rate and a predictable monthly payment. Most lenders feature rapid approval and funding times.

Some of the best debt consolidation loan lenders even offer discounted rates on personal loans used for debt consolidation. Even better still, some will pay off your creditors directly to save you time.

However, you may incur origination fees of up to 12 percent if you take out a loan. You could also be subject to prepayment fees if you decide to pay the loan off early.

Peer-to-peer loan

Peer-to-peer loans are funded by individual investors. Companies like Prosper match these investors to applicants who meet their lending criteria. You may be eligible for a loan even if you don’t have perfect credit.

The downside is your borrowing costs may be higher with poor credit than they would if you took out a secured loan, like a home equity loan. Some peer-to-peer loans also come with brief repayment periods, which may result in high payments over a short time.

Balance transfer credit card

If you qualify for a balance transfer credit card and budget right, you might be able to avoid interest altogether. There are parameters to be aware of, however, and you should know the full process before applying.

Some balance transfer credit cards come with a 0 percent APR introductory period. After opening the card, you’ll have between 12 and 18 months to pay down your transferred balance without incurring interest. You may have to make your transfers within a certain window — often 60 to 120 days after opening the card — and will generally have to pay a 3 percent to 5 percent fee on transferred balances.

But beware: If you still have a balance at the end of the introductory period, you will be charged interest. Average credit card interest rates are higher than average personal loan rates.

Which is right for you?

If you have bad credit, a secured personal loan could be a viable way to get the funds you need. Homeowners can benefit from either a home equity loan or HELOC, allowing them to access necessary funds without needing an excellent credit score. Of course, your home is on the line if you’re unable to repay, but it allows you to access the equity you have in your home to meet immediate financial needs.

If you’re not a homeowner, you could still potentially get an unsecured personal loan with less-than-perfect credit. And for those with solid credit, you could get a low rate while avoiding tying up your home’s equity by getting an excellent credit personal loan or balance transfer credit card.

How to get a debt consolidation loan

You can apply for a debt consolidation loan through a traditional bank, credit union or online lender. Ideally, you should have a credit score in the mid-600s and a debt-to-income (DTI) ratio that doesn’t exceed 36 percent to have the best chance at qualifying for a loan with competitive terms. A lower credit score won’t automatically result in a denial, but you can expect higher borrowing costs and less favorable loan terms.

Be mindful that each lender has unique eligibility requirements. Research or contact a customer service rep before you apply, and choose a debt consolidation lender that serves customers like you.

Bottom line

A debt consolidation loan makes managing multiple debt accounts easier. You can pay off your balances faster and save on interest. Weigh your options between secured and unsecured loans before applying to get the right loan for your finances.