Is it a good idea to use a secured loan to consolidate your multiple debts?
Yes and no.
Just like all debt relief strategies, using secured loans have advantages and disadvantages. It is important for you to get to know it better before you decide if it is the right option for you to use.
Secured loans are characterized by having collateral. This collateral is an asset of the borrower that acts as a “pledge” for the debt. In case the borrower fails to pay off the loan, the lender will take the collateral (borrower’s asset). It will be used as payment for the loan instead.
It is this collateral that makes the debt a “secured” loan. The lender has the security of a payment fall-back in case the borrower cannot meet their payment obligations.
One of the most popular options for this type of debt is a home equity loan. According to one report, more than 4 out of 10 homeowners have opted to use this to consolidate debt. Some even use it to pay for house bills.
So if you are a homeowner planning to use their home to pay for debts, consider the implications of that carefully. You need to get to know the pros and cons before you finalize your decision to put your home on the line just so you can completely pay off your debts.
Pros and cons of using a secured loan to consolidate debt
How can a secured loan help with debt? If you use a home equity loan, you will base the loan amount on accumulated equity in your home. It is usually just a percentage of the current equity. So if your home has equity of $200,000, you can borrow a percentage of that. Let us assume your total credit card debt is $25,000 and you have $45,000 worth of student loans from private lenders. You can borrow $70,000 against the equity of your loan. You will pay your credit card debt and student loans in full. Then you will pay back the $70,000 that is now added to your mortgage.
Now that you know how the process works, how will this benefit you?
There are two main advantages when you use a secured loan to consolidate debts. The more popular advantage is the low-interest rate. Lenders and creditors usually give a high-interest rate to a loan that they think has the highest risk of not being paid back. Since you are using your home as collateral, they feel secure about being repaid. They know that the loss of the collateral will force you to pay. And even if it does not, they can use the property to pay for what they lost. This is why they do not feel the need to give a high-interest rate. And if you have a lot of high-interest credit card debts, this will really help you save a lot of money. The average credit card interest rate is 17% – so you can just imagine how much that will cost you.
Another advantage of using a secured loan is the fact that you are actually using your own equity. It is true that you still have to apply for the loan through a lender. But that is already part of your personal assets. It should be easier to get a loan even if you have a bad credit score.
While the pros of using a secured loan can make it appealing, you still have to consider the risks you are taking. First of all, you are putting your property on the line. If something happened that compromises your ability to pay back the loan, you can say goodbye to your home. What should have been an asset or something that can add to your retirement money is now gone.
Also, doing this will not really solve the problem. If you got into debt because you maxed out credit cards, paying it off through a secured loan will just leave it with zero balance. And that balance will be tempting for you. If you cannot control your spending urges, or accept that you have a problem in that area in the first place, then you will land in the same situation again. And the next time it happens, you might no longer be able to rely on a secured loan to get you out of the financial mess you made.
How to ensure the secured loan will lead to debt freedom
If you decide to use secured loans to get out of debt, that is okay. The truth is, it can help you get out of debt. It can make your financial situation better. And it is possible to do that without compromising the property that you put up as collateral.
This debt relief strategy can help make your monthly payments easier. Here are some tips that will help ensure that all your efforts will only lead to debt freedom.
Have a realistic repayment plan
First of all, you need to start with a realistic repayment plan. Make sure this plan has a timeline and a set monthly amount that you will have to pay. This amount should be aligned with what your budget plan can afford. This is how you can make it realistic. You start by taking into consideration your income and expenses. Since this is a secured loan, you should already know how much you will owe each month. Make sure this amount is listed as a priority payment in your budget plan. This will ensure that it will always be funded. If your income cannot cover all the expenses, then you need to choose from the other expenses on the list. Your debt payments should be a priority because if not, you can lose your home.
Do not use the money on something else
Another tip to ensure that using a secured loan will work is to make sure you use it for your debts only. Going back to the example provided, if you only need $70,000, that is the amount that you should borrow. Even if you can qualify to borrow up to $100,000, do not do it. Stick to what you only need. Otherwise, you will end up with more debt than when you started.
Solve the real cause of debt
Finally, you should also make sure that you solve what really caused your debt problems. Was it overspending? Or maybe there was an emergency that you were not prepared for? If this is the case, then you need to make sure that these will no longer put you in another debt situation. That means you need to learn how to live below your means. This will allow you to get used to spending less. The extra money that you save can be used to make your emergency fund grow. That way, unexpected expenses will not force you into debt.