The two main categories that loans fall into are unsecured and secured loans. An unsecured loan is a loan that refers to any payment plan on a debt or obligation to a creditor. This debt is not collateralized, or protected against bankruptcy or liquidation. The borrower is relying solely on your promise to pay, and would not be able to seize any assets or capitalize on any liens in the event that the debtor can not pay back the loan.
Though unsecured loans are not protected by the assets of the borrower, in some jurisdictions, unsecured creditors are required to set off debts, which actually puts the creditor in a pre-preferential position.
Unsecured loans are also known by the names “personal loans” and “signature loans,” taken from the fact that many are agreed upon just a signature. Most unsecured loans are for smaller, non emergency purchases. One of the most common types of unsecured loans include the credit card.
Unsecured loans, because they are not protected by liens on assets, carry a higher interest rate than secured loans. They are also known as “high yield loans” because of this. Pre payment penalties may often apply if the borrower pays back the loan early.
Secured loans are loans that protect the lender with an asset of the borrower. This asset is called collateral. If the borrower can not pay back the loan, the lender will take possession of the asset.
Secured loans are often taken by borrowers for bigger purchases and common collateral for these loans can include houses in the form of second mortgages, and cars, in the form of a title loan.
Since secured loans protect the lender with an asset, the interest rate is usually lower than that of an unsecured loan.
What is debt consolidation?
Debt consolidation refers to the process of taking out one loan in order to pay off many other loans. Often, debt consolidation is done when other loans become financially burdensome for the borrower. Debt consolidation loans often offer lower interest rates, or can change many variable rate loans into a fixed rate loan.
Debt consolidators, to ensure at least partial payback, will often extend the life or discount the amount of the loan to ease the immediate financial burden of the borrower.
Most often, debt consolidation is a secured loan.
Advantages of a debt consolidation loan
Debt consolidation companies, as a rule of business, attempt to buy the loan of a borrower in financial trouble at a discount. They can then profit by offering the borrower a lower interest rate by passing along the savings, which also saves the borrower money.
Debt consolidation loans are advisable when many loans become too burdensome to pay for a borrower. Especially in the case of credit card debt, because credit cards carry higher interest rates than either secured or unsecured bank loans, debt consolidation in theory is the most prudent solution.
What is an unsecured debt consolidation loan?
An unsecured debt consolidation loan, like an unsecured loan, is a consolidated loan without an offering of collateral as protection against default from the borrower to the lender. An unsecured debt consolidation loan is considerably harder to get than a secured debt consolidation loan because of this lack of protection. Unsecured debt consolidation carries higher interest rates.
An unsecured consolidation loan is more likely to be given to borrowers with a paying job who are part of a credit union.
What is a secured debt consolidation loan?
A secured debt consolidation loan is a consolidated loan with an offering of collateral as protection against default from the borrower to the lender. Often this collateral is a large asset, like a house or a car.
Home equity is a common asset used by borrowers to collateralize a secured loan, because home equity loans used for debt consolidation usually carries the lowest interest rate accessible to a borrower. There are three main ways to access home equity to pay off a loan:
Cash out refinancing. To use this technique to consolidate loans, the borrower must pay off the current mortgage and take out a larger one. After the refinancing, the borrower is given the difference between the value of the home and the larger value of money borrowed. This difference is given in cash and can be used to pay off loans.
The home equity loan. This technique of borrowing to consolidate loans on home equity is also known as “taking out a second mortgage.” Borrowers are given the amount taken out of the equity value in cash.
Home equity line of credit (HELOC). Instead of receiving cash for equity taken out of a home, the home equity line of credit is a credit line extended to a borrower. Borrowers can write checks to pay back loans and consolidate their loans by paying back the credit given against the home equity.
