Secured debt consolidation is one of your options to get out of debt. It is basically a secured loan that you can borrow so you can consolidate your multiple debts. When a loan is secured, that means it is borrowed against collateral. This gives the lender a sense of security. In case you fail to pay back the loan, they will just get the collateral as payment.
What is great about this type of debt consolidation strategy is that you can get the loan with low interest. This is a result of the collateral provided. This is why this is a great option to consolidate credit card debt – which is notorious for their high-interest rates. The low-interest rates will help you save a lot of money in the long run.
Types of secured debt consolidation
There are a few ways to go about a secured type of debt consolidation. Here are some of them worth looking into to help you decide on the best one that fits your current situation.
This is the most popular option for secured debt consolidation. You will use the equity of a property that you own. Reports reveal that the increasing value of home equity is encouraging homeowners into tapping that asset. The equity is the value of the house or property that belongs to you. This is why real estate owners can use their properties even if they have yet to completely pay off their mortgage. They can borrow against the equity of the house.
There are a couple of ways to do this.
- Home Equity Loans. This involves a loan that is borrowed based on the equity that you paid in your home or property. If your equity is at $100,000, you can borrow up to a certain level – like until $80,000. When you borrow a home equity loan, this is usually considered as a second loan that is separate from your initial mortgage. You will end up with two loans.
- Cash Out Refinancing. This will also borrow against the equity of your home. However, it will not be considered as a second loan. You will be borrowing a bigger mortgage so you can cash out your equity. You will still be left with one mortgage but with a bigger balance.
Another option is to use your vehicles. Even if you haven’t finished paying it off, you can also use this as a secured debt consolidation option. Like the real estate, you can only borrow against the value that you have paid off. Here are the two options to do this.
- Cash Out Financing. You can refinance based on the current value of the vehicle. You will be given the cash value and you can use this to pay off your multiple debts. This will leave you with a bigger loan but it should be easier to pay off because you only have one payment to worry about. Not only that, if you borrowed the refinancing with a better credit score, you will enjoy a lower interest rate.
- Title loans. This is like pawning the title of your car. This is considered as the “payday loan” of auto loans. While it will not require a credit check, it will leave you with a high interest rate on the loan. Just make sure that you have a plan to pay back the loan so you will not be caught up in the debt cycle that is usually associated with these type of debts. This is best for those with an urgent need for cash. If there is no urgency, you might want to go for the other option.
This might be a bit more controversial compared to the other types of secured debt consolidation. Some people will not be open to using their 401(k) because it will seem like compromising their future. But if you really want to be free from debt, specifically high-interest rate debts, this is a great tool to use. In fact, reports reveal that the top reason to borrow from a 401(k) is to pay off credit card debts.
Experts encourage consumers to use this as a last resort if none of the options above is applicable. This is your money and if you do it correctly, your retirement might not suffer. You just have to make sure that you get to know the company that services your 401(k) policy. Different companies have varying rules and terms when you get a 401(k) loan. Make sure you get to know it so you can minimize the risks involved with this debt consolidation option.
Secured debt consolidation pitfalls
If you are sure that you want to use secured debt consolidation, get to know the pitfalls that might compromise your road to debt freedom. Some people forget that debt consolidation is merely a repayment strategy and not the actual payment.
Here are some of the pitfalls that you need to avoid when it comes to secured debt consolidation.
- You are putting an asset at risk. Your collateral is an asset that has a positive effect on your financial position. If you fail to pay back the secured loan, you will lose that collateral. This is why you need to be sure that you can pay back your loan so you will never lose your asset.
- The new credit will bring your credit score down. This is a new account after all. Obviously, your credit utilization rate will be affected. The added balance will lower your credit score. While this may seem bad, it will only be temporary. You just have to make sure that you can meet your payments regularly so it will slowly but surely bring your score up.
- There is a possibility of a longer repayment. Of course, this will depend on the terms of the new loan. You can ask to shorten the repayment period but that would mean you have to pay more each month. But if you can only afford a lower monthly payment, you need to be ready to pay for a long time. This will also cost you more in the long run.
If you can avoid these pitfalls, you can make your secured debt consolidation efforts a success. As you pay back the debt, you are regaining the asset that you put up as collateral and you are getting yourself closer to debt freedom.