Secured vs. Unsecured Debt Consolidation Loan: Which is Better?

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 shorten your repayment period by several months or even years. Plus, you can save a bundle in 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 convert various debt balances into a new loan product. Depending on which debt consolidation product you choose, your loan may be collateralized or unsecured.

Ideally, the interest rate on a debt consolidation loan should be lower than what you currently have to maximize cost savings.

You can use a personal loan calculator and a credit card payoff calculator to calculate the potential interest savings with a debt consolidation loan.

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 takes, meaning you may see approval, a larger loan amount, or lower rates more easily.

However, you risk losing your assets if you don’t keep up with payments.

Unsecured Debt Consolidation Loan

Unsecured debt consolidation loans do not require collateral. The loan amount and terms you are approved for are based on your creditworthiness and financial profile.

The advantage is that your assets are not at risk if you fall behind on payments. But your borrowing costs may be higher because these loans pose greater risk to lenders.

Secured loan options for debt consolidation

Secured loans are backed by collateral, making them riskier for borrowers. However, depending on your financial situation, they may be worth it. You can use any of these secured loan products for debt consolidation.

Secured personal loan

This works like a traditional loan and can be easier to access if you have less than perfect credit. Because your collateral lowers the lender’s risk, you may be offered a lower personal loan interest rate than an equivalent unsecured loan.

However, there are also disadvantages that you should take into account. You could get high interest rates and risk losing your collateral if you fall behind on loan payments.

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

Both home loans and HELOCs allow you to convert some of the equity in your home into cash. Home equity is the difference between what your home is worth and what you currently owe.

When you take out a mortgage loan, you receive the entire amount you borrow in one go and pay it back in equal monthly installments. The interest rate is fixed.

A HELOC acts like a credit card. If necessary, you can withdraw money from it. You only pay back what you borrow from a HELOC, and the interest rate is variable.

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

The biggest disadvantage is that you will lose your home to foreclosure if you cannot pay off the loan, as these products act as a second mortgage.

Unsecured Debt Consolidation Loan Options

Unlike secured loans, you don’t have to put up collateral to get approved for these credit options.

Unsecured personal loan

This loan product allows you to consolidate your debts and simplify the repayment process. You get a fixed interest rate and a predictable monthly amount. Most lenders offer fast approval and financing times. Some lenders, like Achieve, even offer discounts on personal loans used for debt consolidation.

However, if you take out a loan, you may be charged an origination fee of up to 12 percent. You may also be fined if you decide to repay the loan early.

Peer-to-peer lending

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

The disadvantage is that your financing costs with bad credit may be higher than if you took out a home equity loan. Additionally, some peer-to-peer loans have a short repayment period.

Credit card balance transfer

If you qualify for a balance transfer and budget credit card, you may be able to avoid interest altogether. Here’s how it works.

Some balance transfer credit cards come with a 0 percent APR introductory period. Once you open the card, you have between 12 and 18 months to pay off your transferred balance interest-free. You may be required to make your transfers within a certain time frame (often 60 to 120 days after opening the card) and you will generally have to pay a 3 to 5 percent fee on the transferred balances.

But please note: If you still have a balance at the end of the introductory period, interest will be charged. The average credit card interest rate is higher than the average interest rate on personal loans.

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 ratio (DTI) of no more than 36 percent to have the best chance of qualifying for a loan with competitive terms. A lower credit score does not automatically result in a denial, but you can expect higher borrowing costs and less favorable loan terms.

Please note that each lender has unique eligibility requirements. Please research or contact a customer service representative before applying. Choose a debt consolidation provider that serves customers like you.

The bottom line

A debt consolidation loan makes managing multiple debt accounts easier. You can pay off your balance faster and save on interest. Before you apply, evaluate the secured and unsecured loans to decide which option is best for you.