Understanding Unsecured Debt Consolidation Loans

Filed Under Finance |

by William Blake

There are two types of debt that consumers can carry: secured debt and unsecured debt. Secured debt is debt that is collateralized by an asset, such as a home or an automobile. This is generally considered safer debt for creditors to extend, since there is an asset backing up the borrower’s ability to pay. Unsecured debt is debt that is not attached to any collateral.

The most common examples of this include credit card debt, student loans, and signature loans. If the borrower on one of these loans stops making payments, the creditor is out of luck, as there is no asset to seize. Interest rates on these types of loans are typically higher because of the addition risk to the lender.

The vast majority of debt consolidation loans are secured, as most end up being second mortgages on homes. However, some borrowers with debt problems do not own homes to use as collateral for loans. These individuals can still get debt consolidation loans, but the loans are not as easy to obtain. The reason for this is that bankruptcy can release people from the obligation to pay off unsecured debt.

If a debt consolidation loan is secured with an asset, the asset can still be seized in the case of a bankruptcy, meaning much less risk for the lender. There are several factors that make unsecured debt consolidation loans more difficult to obtain and use to accomplish financial goals.

First, the only borrowers that will qualify for an unsecured debt consolidation loan are people with good or excellent credit. Many borrowers who have enough debt that they are considering a debt consolidation loan have not done a good job of managing their debt problems in the past, so credit scores are generally lower for people with debt problems. Debt consolidation loans by nature are designed to help people who are in trouble with debt - most lenders aren’t interested in loaning more money to people struggling with debt if there is no asset to mitigate the risk of default.

Second, because lenders take on more risk with an unsecured debt consolidation loans, the loan amounts are generally much smaller, usually ranging from $5000 to $15,000. Again, most borrowers who need to consolidate their debts are in fairly serious trouble with debt, so a loan of $15,000 may not be enough to pay off their outstanding loans.

Finally, there are fewer lenders who are willing to extend a loan that is not secured for debt consolidation purposes. Because the market is smaller and the level of risk is higher than secured debt situations, interest rates are generally significantly higher and fees are usually higher as well. These loans are expensive to ensure that the only borrowers using unsecured debt consolidation loans are serious about getting out of debt.

Debt consolidation loans do help people get out of debt and are effective when used correctly, but borrowers will have a much easier time using them if they have assets to secure the debt.

About the Author:

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