How Unsecured Debt Consolidation Loans Work
When you receive an unsecured debt consolidation loan, you are taking all of your debts – which are usually short term loans, credit card debts or even private student loans – and putting them all into one loan. This enables you to make one monthly payment to one lender instead of sending out multiple payments each month. This eliminates the need for juggling loans and it can seem like a way to better manage your finances, but as you will learn, deciding to take out an unsecured debt consolidation loan is a lot more complicated than it may seem.
Unsecured vs. Secured
Since the loan is unsecured, you do not need collateral for an unsecured debt consolidation loan. Instead, your approval is based on different factors like your income, your credit and your payment history. This can have both advantages and disadvantages.
The advantage of having an unsecured loan over a secured loan is that you don’t have to worry about losing your collateral, should you default in your payments. Not needing collateral, however, does not mean that it’s okay to default on your loan. You will still have consequences, should you fail to make your payments on time. This can include damage to your credit as well as wage garnishment, should you stop making your payments altogether.
The biggest disadvantage to choosing an unsecured debt consolidation loan over a secured consolidation loan is the interest rate. Interest rates for secured loans are significantly lower than the rates for an unsecured loan. This is due to the fact that, with an unsecured loan, the lender must take a higher risk when extending you credit.
Difficulty in Getting Approved
Getting approved for an unsecured loan is a lot more difficult than some people may realize. Not only is your credit a factor, so is your previous payment history, your job status, your income level and your other financial responsibilities. All of these factors are used to determine if you can be extended a line of credit. Some of these factors will also impact your loan terms.
Understanding the Impact of Interest
Some individuals assume that the interest rate for their consolidation loan is a trade-off for the lower monthly payment but this is rarely the case. In most cases, you will pay more over the life of your consolidated loan than you would have, had you kept your previous creditors and worked on a better plan for managing your payments. This is often missed by individuals that apply for a consolidation loan. They only see the lower monthly payment.
What you must realize, however, is that the higher payments you were making on your previous loans meant that you didn’t have to pay as much interest over the life of the loan. It also meant that you didn’t have as long of a repayment commitment. A consolidation loan is a long term commitment – one you should not take lightly.
Not an Answer to Credit Problems
One of the biggest mistakes that individuals make when considering an unsecured debt consolidation loan is assuming that it is an answer to their credit problems. While it is true that having one payment is easier to manage than multiple payments it still takes discipline – better money management and budgeting – to make debt consolidation effective. If you don’t practice new methods for handling your monthly expenses, you will end up right where you started – behind and struggling to make your payments.
Learning How to Manage Your Credit
The purpose of a debt consolidation loan is not to free up your money so you can find new ways to get more credit – that’s often what lands people in trouble. New ways of handling your finances can help you learn how to effectively manage your debts and your monthly expenses. This will help you stay on track with your new loan. It will also help you stay out of trouble, once you start to rebuild your credit.
A few places that you can learn better money management is through online tools and even financial classes. While these tools may seem like a waste of your time, keep in mind how important it is to learn how to effectively manage your credit and monthly expenses. Use your debt consolidation loan as a way to have time to learn more about budgeting, about financial plans, about savings plans and about paying your bills on time. If you do this, you will soon be on track to a better credit and financial status.