When Does a Secured Consolidation Loan for Credit Card Debt Make Sense?
Debt consolidation loans bundle old debts — usually credit card balances — into new debt in the form of a loan with fixed installments. This can bring borrowers relief not only from having to manage a whole slew of monthly statements, but also from paying the high average interest rates associated with credit cards.
There is a catch, however. Without strong credit on your side, it’s not always easy, or even possible, to apply for the consolidation loans with the most desirable interest rates. Since lenders use credit as a way to gauge borrowers’ risk of default, they will typically reward good credit with low interest rates.
What are your options if you’re a borrower who’d like to consolidate but has, say, average or even bad credit? Exploring a secured loan is one potential way to improve the loan terms for which you’re able to qualify.
Here’s more on when a secured loan for consolidation may make sense — and the risks of going this route, too.
Differences Between Unsecured vs. Secured Consolidation Loans
Debt consolidation loans are usually unsecured. Under this type of agreement, you don’t have to offer up a piece of property as collateral; your credit rating is what’s most at stake if you were to default on the loan. These types of loans are higher risk for lenders, so they may restrict them to borrowers with strong credit, or at least increase the interest rate for borrowers with lower credit.
Secured loans, on the other hand, are tied to a piece of collateral, which the lender then has the right to seize if you default on the terms of your loan — in addition to hurting your credit score. The two examples of secured loans that probably jump to mind are mortgages and auto loans, although personal loans can sometimes be secured as well.
Lenders will grant an unsecured loan based on your credit score. However, if you’re not deemed creditworthy, the loan provider may turn you down unless you assign collateral to secure your borrowing.
If your credit score isn’t good and you’re not willing to sign up for a secured consolidation loan, you may want to consider bad credit debt consolidation loans. These are typically offered by online loan providers who specialize in lending to borrowers with bad credit. An unsecured debt consolidation loan is less risky but may not be granted to someone with bad or poor credit.
When Might a Secured Consolidation Loan Make Sense?
As we mentioned earlier, borrowers with high credit scores are more likely to get approved for favorable loans. However, this doesn’t mean borrowers with less-than-ideal credit are totally out of the running — it just means they might need to try a different approach if a traditional unsecured loan isn’t a reality right now.
Secured debt consolidation loans for bad credit counteract some of the risk lenders take on when they loan money to borrowers with subpar credit. So, by offering up an asset to back up your promise to repay your loan in full, you’re increasing your chances of getting approved and/or getting an offer at a reasonable interest rate.
Should you get a secured consolidation loan? It depends on your purpose and capability to repay. Since you’re putting up your asset as a guarantee, you may lose your possession if you can’t handle the loan repayment. Answer the following questions before applying for a secured consolidation loan:
- Will I pay lower interest rates upon consolidating my credit card debt into one loan?
- Can I afford the repayment scheme of the consolidated debt?
- What fees do I have to pay to consolidate my credit card balances?
- Am I working with a reputable debt consolidation loan provider?
- Will my credit rating improve when I get a secured consolidation loan for my multiple credit card debts?
- How will consolidating my credit card debt lower my debt-to-income ratio??
Risks of Taking on a Secured Loan
While choosing a secured loan can help you find an entry point into getting approved for consolidation, it does put your property at risk — specifically whatever item(s) of value you decided to put up as collateral against the loan.
If you miss enough payments and default on your loan, the lender can repossess your property. It may then sell that property to try to make back the money it lost when you defaulted. However, as The Balance warns, the sale of your assets may not cover the full value of what you owe on the loan, in which case you could still owe the remaining balance.
Taking on any kind of consolidation loan is a serious commitment, but especially one backed by your property. This means you need to have a realistic plan for making consistent payments for as long as it takes to fulfill your obligations — often around five years, give or take some. Taking on a secured loan without knowing all the terms and conditions can leave you in a deeper debt hole than you were before.