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Published 07 May 2021

What’s the difference between a secured and unsecured debt consolidation loan?

There are two main types of debt consolidation loans: unsecured and secured. Secured loans require collateral, unsecured loans do not. Offering security to the lender typically provides the borrower with access to larger sums of money.

You can use either an unsecured or a secured debt consolidation loan to combine your repayments, but which option is best for you?

Debt consolidation loans enable you to raise money to ‘repay’ any outstanding debts you have – such as credit cards, overdrafts, or other loans – and bring the amounts together so you have just one loan to repay each month.

This could make your debts easier to manage – since you have essentially merged them all into one place – and gives you one fixed interest rate and date at which you can become debt-free,

There are two main types of debt consolidation loan: unsecured and secured.

Unsecured loans are also referred to as personal loans, while secured loans are sometimes called homeowner loans or second charge mortgages.

» MORE: What is an unsecured loan?

What are unsecured debt consolidation loans?

An unsecured debt consolidation loan allows you to borrow money to repay other debtsIt is a standard personal loan, and you pay the money back, plus interest every month for a fixed period of time, after which point the loan is repaid.

What are secured debt consolidation loans?

A secured loan works in the same way as an unsecured loan, the main difference is that you need to put up an asset, normally your home or a car, as ‘collateral’ or ‘security’ for the lender. This means that if you don’t repay the debt, the lender can make a claim on that asset.

» MORE: What to do when struggling with secured debt

Unsecured vs secured debt consolidation loans

The best option for you will depend on your circumstances, your credit score, the amount of money you need to borrow and the length of time over which you will be repaying it.

Unsecured loans are the lower risk option simply because you don’t risk losing your home if you can’t meet repayments, but interest rates tend to be higher than on secured loans.

However, there may be some reasons to consider a secured loan. Because the lender has your home as security, it may be willing to lend you a larger sum, sometimes up to £100,000 or more. Typically, the maximum you can borrow with a personal unsecured loan is £25,000. Interest rates are likely to be lower too.

A secured loan may also be your only option if you have a poor credit score. So long as you own your own home, eligibility criteria is assessed differently with unsecured loans because the lender has your home as security.

You may also be able to set a longer term on a secured loan. Terms on secured loans are typically between five and 25 years. Although interest charges can rack up on lengthier loans, it can make monthly repayments more affordable if you are stretched.

Unsecured loans in contrast usually run for between one and five years.

How to get a debt consolidation loan

You can compare personal loans for debt consolidation. It’s helpful to use a free eligibility checker – after answering a few questions online, these will let you know which deals you are likely to be accepted for, without affecting your credit record.

You don’t necessarily have to use loans that are specifically for borrowers consolidating their debts. But before you apply, it’s important to check that they allow loans for debt consolidation.

When you apply you will need to supply some basic personal and financial information. The lender will also run a credit check on you before it approves your loan to find out whether you have ever had difficulty repaying debts in the past.

In the case of secured loans the lender will take you through a much more complex mortgage style application and also want to know how much house equity you have in your property. This is the amount of money you would have after repaying the mortgage if you were to sell your home. The more equity you have, the more confident the lender will be in granting the loan.

The alternatives

If you have a good credit score and are consolidating debts for reasons of efficiency rather than serious problems, you should be able to do so with a standard personal unsecured loan. You do not need to choose one that is specifically called a ‘debt consolidation’ loan.

However, it is worth bearing in mind that even with the most competitive deals, interest rates are typically higher on smaller loan amounts. If you think you could repay the money in a year or two, it might make sense to opt for a low or 0% interest money transfer or balance transfer credit card.

In addition to lowering your interest costs, a credit card may be more flexible as you can vary your repayments each month. However, it is important you meet minimum repayments and repay the debt before any 0% offer comes to an end, or transfer the debt onto another interest-free deal, or you risk being charged high interest.

If you are worried about repaying your debts, even once they have been consolidated, it may be worth getting some free advice from a debt advice charity. It can advise on the most sensible options for you and may be able to negotiate a repayment plan with creditors on your behalf.

Can a government debt consolidation loan help?

You may hear some debt management companies promoting so-called ‘government debt consolidation loans’. However, there is no such thing as a government debt consolidation loan.

The only government-backed schemes for dealing with debts are solutions including bankruptcy and individual voluntary arrangements (IVAs), although these are not loans and you do not need to pay a debt management company to set them up. A debt advice charity will be able to discuss all your options with you and make arrangements for you, free of charge.

Image source: Getty Images

About the Author

Rachel Lacey

Rachel Lacey is a freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all.

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