Are you thinking about using a secured loan to consolidate your multiple debts? When it comes to consumer debt, Americans have a lot of pay off. Statistics reveal that the end of 2018 left consumers with a total of $13.3 trillion worth of debts. Of that amount, the revolving debt has reached $4.1 trillion. That is worth mentioning because revolving debts usually have the highest interest rate compared to other types of debt. Obviously, you need to get rid of these high-interest debts because it poses the biggest threat to your financial future.
But what is the best way to deal with these high-interest debts? The logical solution is to find a way to lower the interest rate.
There are many ways for you to lower the interest rate on your multiple debts. One of the effective options is to use a secured loan. This is a type of loan that requires collateral. You will borrow against the value of the collateral. If it is valued at $100,000, you can borrow a percentage of that.
But how beneficial can it really be to use your collateral to pay off debt? And what are the pitfalls that you should consider when using a secured loan to consolidate debt?
Advantages of using a secured loan
Let us start with the advantages of using collateral to consolidate debt. The most common collateral used by consumers is their homes. They use the accumulated equity that represents that value of the house that they already own. Consumers borrow against the equity of their home to get the cash that they need to consolidate debt.
Since the prices of homes are currently appreciating, that means homeowners have more equity at their disposal. Reports reveal homeowners have $5.9 trillion of equity to use. While most of them will probably use it to renovate their homes to increase their value, there are some people who have the option to use it to consolidate multiple debts.
How exactly can that benefit your finances?
Lower interest rate
Since this is a secured loan, you can get a lower interest rate. This will work really well if you have a lot of high-interest rate debts – like credit card debts. When you consolidate this way, you can pay off the high-interest debts and be left with the low-interest loan that you borrowed. This will help you save a lot of money in the long run. At least, if you consider the interest amount that you will be paying through this loan.
Bad credit score
Another benefit of using a secured loan to consolidate your debts is you can still enjoy the lower rate despite a bad credit score. If your credit score is less than stellar, it will be harder for you to get an unsecured loan. But since you are borrowing against collateral, the lender will be more inclined to give you a lower rate. And as you pay off the loan that you used to consolidate, you can take advantage of making better payments so you can improve your credit score.
Motivation to pay off debt
Finally, having the collateral tied to the loan should motivate you to pay off the debt. If you fail to pay off the debt, you will lose it. The lender will use it as payment for the secured loan. That means if you used your home, you will lose that. You will end up being homeless or back to paying rent. If you were counting on your home to help you through retirement, that will no longer be possible. If that is not enough to motivate you to pay your loan on time, then you will have a huge problem in the future.
Disadvantages of using a secured loan
While the benefits of using a secured loan make it appealing, you need to get to know the disadvantage of using collateral to understand the pitfalls you have to avoid. It will motivate you to ensure the success of your consolidation efforts.
With that, here are the two disadvantages of using a secured loan.
You can lose your collaterals
Some people will risk their ownership of the collateral and use it to motivate themselves to pay off the debt. However, not everyone is like that. Some people react differently. They would feel more complacent with their debt situation because of the lower interest and the single monthly payment. Since everything seems more simple, it could lead them to be careless. This is a mistake that can lead them to fail at getting out of debt. You need to ensure your payments are on time so you will not lose your collateral.
You might increase your debt balance
Another disadvantage of using a secured loan is increasing the amount that you owe. There is a chance of you feeling so complacent about your debt situation – since you have a lower rate and one monthly payment. If you fall into a false sense of debt freedom, you might end up using your credit cards again. After all, these would probably have no balance already because you paid them off with the secured loan. Make sure you keep in mind that you still owe the same amount of debt. All of it is just conveniently transferred under one loan.