Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan.
- Secure vs. unsecured loans: A secured loan occurs when a valuable asset (e.g. a house or a car) serves as collateral in case the debtor stops making payments (known as default). If default occurs, then the company that loaned the money can legally repossess your house or car. An unsecured loan, however, merely uses the debtor’s credit to back the loan. Because of the collateral, companies are willing to offer lower interest rates with a secured loan.
- Advantages of consolidating with a secured loan: Often, secured loans carry lower interest rates than unsecured loans. Therefore, they may save your money on interest payments. Lower interest rates will likely make the monthly payment lower and more affordable. Sometimes, the interest payments are even tax deductible.
- Advantages of consolidating with an unsecured loan: No property is at risk. Also, while the interest rate may be higher than a secured loan, it might be less than what is charged on several different credit card balances. This lowers your interest burden and your payment.
- Consolidating your debts into one loan with one lower monthly payment provides you with a great deal of emotional and financial relief. It makes you feel confident about your financial situation again.